ECONOMIC TRENDS AND OUTLOOK:
INDONESIA 1998

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Summary
Challenges for the Habibie Government
U.S. Business Interests – On Hold
Response to the Crisis -- The IMF Program
Fiscal Policy
Monetary and Exchange Rate Policy
Structural Reform and Deregulation
Corporate Debt and Bankruptcy
Banking Sector Reform
Trade Issues
Food Security and Distribution
Negative Outlook for Major Sectors

Country Data
Domestic Economy
Trade (USD Billions)

Summary

Indonesia was widely hailed as a leading economic success story as recently as mid-1997. Real GDP growth averaged over 7 percent per year for the decade since 1987. GDP per capita surpassed US$ 1,000 by 1996, compared with US$ 70 in 1965. The rupiah was stable. Annual inflation was reported in the single digits. Foreign capital was pouring in.

The economic crisis that began in July 1997 changed all that. Indonesia experienced severe drought, low world petroleum prices, regional financial instability, domestic social unrest, and, ultimately, a change of government. By mid-1998, the government estimated that real GDP would contract 13 percent during 1998; private analysts projected a decline as large as 25 percent. GDP per capita had declined to US$ 450. The exchange rate plummeted from 2,450/US$ in June 1997 to 15,000/US$ a year later. Exchange rate volatility made business planning all but impossible. Annual inflation was running at an estimated 80 percent and the potential for higher inflation remained a worry. Foreign capital had fled, closing off access to new foreign lending, while the business sector struggled to service existing foreign debts at increasingly unfavorable exchange rates. Most observers agreed that the economy had not yet bottomed out as of mid-1998, making it difficult to chart a path toward recovery.

The shock waves from this sudden reversal of fortune reverberated among a generation familiar only with economic growth. The reversal cast into stark relief weaknesses that were downplayed during the preceding high growth period, including presidential succession uncertainty, corruption, collusion, and nepotism, a weak banking sector, and the large but then-unknown amount of foreign commercial debt. As employment dropped and prices rose, the loss of purchasing power, particularly among lower income groups, raised concerns about the ability of the population to feed itself and about the potential for social unrest. In may 1998, after fuel prices were increased and demonstrating students were shot, riots and looting swept Jakarta and other cities, leading to the May 21 resignation of President Soeharto, who was replaced by his Vice President, B.J. Habibie. President Habibie announced that presidential elections would be held in December 1999.

The deep financial, economic, and political crisis that developed during 1997-98 obscured underlying strengths of the Indonesian economy. With a population of 201 million, the world’s fourth largest country was the anchor of Southeast Asia and a sizable market with an emerging middle class. Its strategic location, large labor force earning relatively low wages, abundant natural resources, financial and trade sector deregulation efforts, and stable political climate had unleashed a domestic and foreign investment boom and fueled the development of a robust manufacturing economy concentrated on the main island of Java. Once dependent on petroleum, natural gas, and commodities including coffee, tea, spices, timber, and shrimp, Indonesia by 1997 exported US$ 45 billion in non-petroleum, labor-intensive products such as garments, footwear, plywood, and basic machinery, on top of its US$ 12 billion in oil and gas exports. It had also become a significant market and imported US$ 5 billion in goods from the United States in 1997.

Challenges for the Habibie Government

The list of challenges facing the new Habibie government in mid-1998 was daunting:

• The financial sector was in dire condition. Many major banks were surviving only because of direct government liquidity support, most loans were thought to be non-performing, and public confidence in banks was low. A major overhaul of the financial sector was just beginning, and it was not clear how many banks would emerge from it or how recapitalization of banks would be funded.

• The external debt burden was a drag on confidence and recovery. Indonesian private banks and businesses owed roughly US$ 73 billion to foreign creditors, and the Indonesian government owed another US$ 66 billion. Private bank and corporate debt rescheduling talks were underway, but were likely to be protracted, meaning that there would be a delay in the resumption of foreign lending to Indonesian businesses. Lack of offshore trade financing was hindering export growth. Sovereign debt rescheduling was under discussion.

• The real sector continued to contract, leading to concerns about massive unemployment. Each week brought additional reports of firms cutting back or ceasing operations, as inputs became unavailable and demand slumped. Construction sites stood idle and factories empty. An estimated 9 million persons in the wage-earning economy were unemployed as of April 1998, and the number was expected to reach 13 million by the end of the year, up from 4 million at the end of 1997.

• The food situation was a growing concern, more in terms of affordability for lower income groups than of availability. The government was subsidizing prices of essential commodities such as rice, but the subsidies had become a serious drain on the government budget, and food price increases continued. Though reliable statistics were unavailable, the share of the population in poverty was increasing.

• The government’s budget deficit was expected to reach 8-10 percent of GDP in fiscal year 1998/99 (April-March).

• The political climate remained uncertain. The Habibie government appeared to be consolidating its hold on the machinery of government, but there was wide disagreement within society about its legitimacy and about how the political reform process should proceed. General parliamentary elections were scheduled for mid-1999, to be followed by parliament’s election of a president in December 1999.

• The riots of mid-May 1998 remained a traumatic issue, particularly for the ethnic-Chinese minority who dominate Indonesia’s modern economy.

Although Indonesia still had many of the factors that fueled its earlier growth – abundant natural resources, a large and literate population, a modest birth rate, and modern infrastructure – and had begun to introduce economic reforms, the timing of economic recovery remained uncertain. As poor as conditions were, few observers believed that economic activity had bottomed out. Recovery appeared likely to be a painful, years-long process. An overriding issue was the restoration of sufficient confidence to encourage domestic businesses and foreign investors to resume their activities.

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