Regions and Countries

	Table of Contents
p. 2 of 15 BACK | NEXT Map Executive Summary I. Recent Economic Developments II. Short and Medium-Term Economic Prospects and Policy Issues III. Corruption as a Challenge to Development Appendix

Country Economic Review - Indonesia

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Executive Summary

Like many Southeast Asian countries, Indonesia experienced slowing growth in 2001. Exports fell, responding quickly to weakening external markets, first as a result of the bursting technology stock market "bubble" and then of the 11 September terrorist attacks in the United States (US). With weaker prospects for exports, investment in plant and equipment has slowed. International conditions after the terrorist attacks, combined with highly publicized governance problems in the legal and judicial systems and continuing security concerns in some regions of Indonesia, have discouraged investment, especially foreign investment. These developments overshadowed generally positive news, including the peaceful change in governments and the steady, incremental progress in some aspects of economic policy. Signs of some rebound in market confidence were apparent in late 2001 and early 2002, with improvements in stock and bond market indexes. Whether this will have a broad impact on real investment and in other asset markets remains to be seen.

Households responded positively to the environment in 2001. Income growth in 2000 signaled the end to the long recession stemming from the Asian financial crisis. Solid wage increases followed for manufacturing and service sector employees. Large increases for minimum wages in 2000 and 2001 supported spending by some families. Rural populations, suffering from stagnant agriculture productivity, and those in the large informal sector saw little income growth. Security concerns continue to limit economic activity in some regions.

The Government enjoys only a limited degree of fiscal policy freedom. Domestic revenues are hard to raise with governance problems hindering tax collection efforts, and a lack of firm political consensus slowing privatization sales. (Weak domestic resource mobilization is one link between governance and development, as noted in the final section to this report.) External and internal debts require large interest payments, and decentralization has shifted control over much revenue to local governments. In April 2002, the Paris Club provided some debt restructuring, but this had been anticipated in the 2002 budget. Within the given constraints, the Government has shown considerable energy in setting and meeting prudent spending targets.

Until recently, monetary policy has accommodated increasing inflationary pressure from rising administered fuel and utility prices. Inflation crept back to above 10% early in 2001 and may be difficult to tame in the short term. By mid-2002 there is some evidence that monetary policy has become firmer and aided by a stronger domestic currency, inflationary pressure somewhat weaker.

Low investment has raised concerns that future growth prospects will be limited, unlike the strong growth in the decade before the financial crisis, a period that saw rapid, continuous increases in gross domestic product and significant poverty reduction. Investment levels are lower than in the past and lower than in Indonesia's neighbors, and may not be large enough to support adequate capacity expansion and growth that could reduce poverty.

The key to future growth lies in the degree to which the Government can address the outstanding reform agenda, including reducing corruption and improving governance. Financial sector reforms were evident in 2001 and early 2002: banks generally improved their balance sheets, and the Government sold a majority share in one of the largest banks to a foreign-led investment group. The financial sector, however, still does not adequately perform its primary task of commercially based financial intermediation, and this limits investment and growth.

Growth is expected to continue at a moderate pace in 2002 and 2003, sustained by private consumption spending and the anticipated recovery of international markets. The ongoing conflicts in different regions of the country, burdensome public sector debt, and slow progress of necessary reforms, especially those related to governance, constrain higher growth rates. The large household sector will continue to cushion the economy from these impacts, providing that the political situation continues to stabilize .

A discussion on corruption and development, reinforcing the conclusion that strong actions to improve governance can enhance long-term growth prospects, is a special topic at the end of this review.

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