Survey of recent developments

Summary

The composition of the incoming cabinet has been a disappointment: the president's clear election victory seemed to give him the opportunity to appoint a more strongly reformist group of ministers. The new government says it intends to involve the private sector heavily in infrastructure provision, and that it recognises the need to improve the business environment, but there has been little concrete progress so far, and it has yet to show the will and capacity to do what is required.

In late December Aceh province was devastated by an earthquake and a catastrophic tsunami. About a quarter of a million Indonesians were killed and countless others injured. Vast numbers have lost their livelihoods, and material damage is estimated at $3 billion, although the natural gas producing facilities remain intact. The international community showed itself to be favourably disposed to the incoming government, and committed generous disaster assistance.

The economy grew increasingly rapidly in 2004, and investment spending has at last begun to record sustained high rates of growth. The budget outcome for the year is expected to be reasonably close to plan, despite the previous government's failure to reduce the enormous waste resulting from electricity and fuel price subsidies. Monetary policy was tightened toward the end of the year in response to accelerating inflation. A deposit insurance agency to be established under newly enacted legislation is unlikely to be able to prevent banking collapses, or the transfer of the resulting losses to the general public; the legislation seems merely to codify most of the actions taken on an ad hoc basis in 1999–98 when the banking system collapsed. Meanwhile, yet another banking scandal has led to the closure of a private bank, after a seemingly unwarranted delay by the central bank.

The government has announced its intention gradually to adjust electricity and fuel prices upwards. The Constitutional Court has annulled a new electricity law allowing greater private sector participation and competition in this sector, however. Similar court actions now seem likely whenever the government enacts laws aiming to enhance efficiency through these means.

After less than four years of decentralisation, the underlying laws have been replaced. The new laws can be interpreted as an attempt to shift government authority back towards the centre, but there has also been an attempt to redress the regionally inequitable fiscal impact of current revenue sharing arrangements.

Notes

In particular, there has been controversy over whether there should be a strict limit on how long foreign military personnel may remain in Aceh to help tsunami victims and assist with reconstruction. The vice president's assertion that there should be a limit of three months was quickly overturned by the government (Powell 2005).

Source: CEIC Asia Database.

• ^aLending data are adjusted for changes in the CPI

• Source: CEIC Asia Database.

Source: CEIC Asia Database.

The introduction of less onerous reserve requirements for smaller banks provides a strange contrast with BI's desire to bring about a consolidation of the banking system through mergers and acquisitions (Bank Indonesia 2005b).

• ^aCurrency in circulation is the major component of base money. Growth in the latter has been severely distorted by changes during this period in the minimum required reserves that must be held by banks.

• Source: CEIC Asia Database.

The New Year celebration was subdued following the tragic events in Aceh and North Sumatra.

The stated margins are between working capital loan rates and 1-month time deposit rates, averaged across all banks (source: CEIC Asia Database).

Five securities houses are now under investigation for their alleged involvement in the scandal.

Forcing bank owners to inject much larger amounts of equity might persuade at least some of them that they would prefer to employ their capital elsewhere. This, in turn, might result in the sale of some of these banks to other banks, thus encouraging the consolidation of the banking sector as the government wishes.

It seems odd to apply the label ‘infrastructure’ to all these projects. The distinguishing feature of nearly all forms of genuine infrastructure is that they require the acquisition of large tracts of land on which to construct roads, railways, harbours, airports, and distribution systems for water, gas, electricity and land-based telecommunications services. It is the difficulty that would be faced by the private sector in such land acquisition that largely explains the historical tendency of governments to provide such infrastructure. There is no more reason to regard oil tankers and power generation stations as ‘infrastructure’ than trucks and sugar mills.

For example, a recent draft regulation on upstream oil and gas activities stipulates that oil companies are to be subject to duties and other levies on imports, and also to regional taxes and levies. Although the draft states that the Ministry of Finance will reimburse any taxes (other than income tax) required to be paid by the contractor under a Cooperation Contract, the process of obtaining reimbursement from the ministry for tax and levy payments to regional governments will create higher transaction costs in the sector. The draft also introduces various fees that do not exist under current arrangements. For an extended discussion of such issues, see McBeth (2005) and PwC (2004).

An alternative view is that administered price changes like these are merely relative price changes, and so are not inflationary at all, provided the money supply is not adjusted upwards in order to keep ‘core inflation’ steady (McLeod 2003: 314–18). This was the policy of the central bank in the past, but more recently it has dropped the practice of focusing separately on ‘core’ and ‘headline’ inflation (Kenward 2004: 24).

There was a strong element of economic nationalism in the opposition to the new law, with WGPSR later claiming the outcome as a victory of civil society in strengthening Indonesian sovereignty vis-à-vis the economic agenda of the international financial institutions (in particular, the IMF, the World Bank and the Asian Development Bank) (WGPSR 2004).

The law is not explicit on this and many other aspects.

To give a simple example, if a local government prefers to increase its education spending by Rp 1 billion, and then finds itself with additional oil and gas revenues of Rp 0.9 billion notionally tied to education, it could readily choose to spend this entire amount outside the education sector without compromising its eligibility to receive these additional funds.