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Survey article

Survey of recent developments

&
Pages 287-315 | Published online: 16 Nov 2009

Abstract

Indonesia has so far suffered a relatively mild impact from the global financial crisis. Its economy grew at 4% in the year to June 2009, displaying a more resilient response than some of its neighbours. Fiscal stimulus measures, deft monetary policy and cash transfers to the poor served to soften the impact of the crisis. Parliamentary elections in April and presidential elections in July provided further economic stimulus. Election-related spending and the stimulus measures helped maintain formal sector employment levels and the proportion of casual employees in the workforce. Like the cash transfers, payments by parliamentary candidates to voters contributed to household incomes, particularly among the poor. This is reflected in widespread declines in poverty observed in 2009. The crisis, the stimulus package, the direct cash transfers and the election campaign spending combined to create a mechanism of income redistribution in favour of the poor.

On 20 October Susilo Bambang Yudhoyono and Boediono were inaugurated as president and vice president for 2009–14. They announced key economic targets for 2014, including 7% economic growth, 5–6% unemployment and an 8–10% poverty level. It is crucial that the two leaders tackle important reforms – even politically sensitive ones – that will remove obstacles to faster and more employment-friendly growth. However, the plan for their first 100 days focuses on a series of small, politically non-sensitive reforms designed to demonstrate their commitment to, and create momentum for, wider reform. This strategy is unlikely to create an impression that the government is serious about more substantial and essential reforms. Nor is it likely to generate the economic impact necessary to bring the economy closer to the government's key economic targets.

The slow expansion of infrastructure since the 1997–98 crisis is a major obstacle to future high and sustained economic growth. Despite some signs of improvement in recent years, Indonesia's rate of infrastructure investment remains far below pre-crisis levels. Tackling this problem should be a high priority for the government.

While pursuing ways to grow faster, Indonesia – one of the world's largest CO2 emitters-needs to respond more vigorously to climate change. The leaders have pledged to place climate change mitigation high on their policy agenda. Yet little has been said about how, as one of the countries most vulnerable to climate change, Indonesia should support her people's adaptation to its effects. The government needs to give high priority to adaptation and promote it at the international level.

THE ECONOMY AND THE MAJOR EVENTS OF 2009

Four major events captured the attention of the media during 2009: the global financial crisis (GFC), the legislative and presidential elections, the bombing of two luxury hotels in Jakarta, and an earthquake in Padang. Each had the potential to affect the economy significantly. As it turned out, the economy proved resilient in the face of all of these events. The impact of the GFC began to be felt in Indonesia from mid-2008, and was still evident at the time of writing. However, the effects of the crisis on Indonesia have been relatively mild.

Election campaigning commenced in July 2008, and campaign activity intensified noticeably from the end of 2008. The legislative and presidential elections were held on 9 April and 8 July, respectively, and both were largely free of significant disturbance. To the extent that they affected the economy, the impact was stimulatory, partly as a consequence of heavy spending by both the General Elections Commission (Komisi Pemilihan Umum, KPU) and the political parties, and partly because of the calming impact of the re-election of a popular incumbent president.

The twin suicide bombings of the Marriott and Ritz-Carlton hotels in Jakarta occurred on 17 July, little more than a week after the presidential election. After several years with no major terrorist activity, the bombings shocked those who had come to believe that the authorities had dealt successfully with the terrorist threat. Nine people were killed and more than 50 injured in the blast (Tempointer-aktif, 18 July 2009). The police were able to identify a number of suspects relatively quickly, and to capture or kill several of them within the next few months. Although the bombings generated a great deal of media coverage in the following days, they had very little economic impact. The number of tourists entering the country in July and August 2009 was not noticeably affected, nor was the stock market. Nevertheless there is cause for concern that foreign investors might re-evaluate the risks involved in doing business in Indonesia, and perhaps decide to stay away for several more years.

On the evening of 30 September, an earthquake measuring 7.6 on the Richter scale devastated the city of Padang, the capital of West Sumatra province, and surrounding areas, causing widespread loss of life and property. By mid-October it was reported that the death toll had reached approximately 1,100 people, while around 3,000 others had been injured. At least 135,000 houses were heavily damaged, and a further 150,000 suffered medium or mild damage (Tempointeraktif, 14 October 2009). Various local organisations quickly came to Padang to provide support. When President Susilo Bambang Yudhoyono (SBY) gave the green light for foreign assistance the day after the earthquake, various international organisations rushed to the city to add to the relief effort. The cost of reconstructing Padang and smaller towns and villages nearby will be considerable, and there will be a significant impact on the local economy. But as was the case with the Aceh tsunami in 2004 and the Yogyakarta earthquake in 2006, the effects of Padang's earthquake on the national economy will be slight.

Previous surveys (Gunawan and Siregar Citation2009; Kuncoro, Widodo and McLeod Citation2009) have argued that the impact of the GFC on the national economy has been relatively modest. confirms that the decline in Indonesia's growth rate was less severe than that of several other Asian economies. The GDP data for the second quarter (Q2) of 2009 reveal, however, that Indonesia's growth continued to decelerate, albeit slightly, while every other economy shown in managed to reverse the decline in its growth rate. Indonesia's growth nevertheless remained positive, and well above that of Thailand, Malaysia and the Philippines.

FIGURE 1  Economic Growth Rates in Asia (% p.a. year-on-year)

Source: CEIC Asia Database.

FIGURE 1  Economic Growth Rates in Asia (% p.a. year-on-year) Source: CEIC Asia Database.

A number of explanations for the relatively mild impact of the GFC have been suggested.Footnote1 The first draws attention to the structure of the Indonesian economy, and the fact that it is less closely connected to the global economy than those of neighbouring countries, particularly Singapore. Only about 17% of Indonesian output is exported, so the downturn in the US and other major economies has not had a strong impact on Indonesia. In addition, approximately 30% of the labour force is found in the agricultural sector, which is less affected than other sectors by the business cycle.

A second explanation focuses on the favourable impact of government and central bank policy responses. Since October 2008 the government has introduced a number of regulations aimed at protecting the financial system from a potential crisis, and monetary policies have been prudent. A fiscal stimulus package amounting to Rp 71.3 trillion was introduced early in 2009. Most of the stimulus was in the form of tax cuts and subsidies intended to increase spending by the private sector, complemented by an additional Rp 12.8 trillion (originally Rp 10.8 trillion) of government spending, mainly on infrastructure (Gunawan and Siregar Citation2009; Kuncoro, Widodo and McLeod Citation2009). The government also expanded its ‘social expenditures’ rapidly in the first two quarters of 2009 ().Footnote2 Another important policy was to provide to direct cash transfers (bantuan langsung tunai, BLT) to the poor in January and February 2009, amounting to Rp 3.8 trillion. On previous occasions these transfers were intended to compensate the poor for increases in prices following reductions in fuel subsidies, but this time they were used to soften the impact of the GFC on the poor (Kompas, 3 August 2009).

FIGURE 2  Government Social Expenditure a

(Rp trillion/quarter)

a Amounts for the September and December quarters in 2009 are projections.

Source: Agency for Fiscal Policy, Ministry of Finance.

FIGURE 2  Government Social Expenditure a (Rp trillion/quarter) a Amounts for the September and December quarters in 2009 are projections. Source: Agency for Fiscal Policy, Ministry of Finance.

A third explanation for the resilience of the economy in the face of the GFC is the stimulatory impact of the elections. Election-related spending by the government, as well as that by the political parties and the candidates themselves, seems likely to have boosted consumption expenditure. The total budget for the KPU was approximately Rp 47.9 trillion, of which about Rp 18.6 trillion was included in the 2008 budget and Rp 29.3 trillion in the 2009 budget. Information on the amounts actually spent was unavailable at the time of writing, but it seems likely that the bulk of this allocation would have been spent by the end of July 2009. In rough terms, it could be said that the government spent about Rp 50 trillion on the elections over a period of about one year; this may be compared with total government expenditure of the order of Rp 1,000 trillion in 2008. In other words, paying for the election would appear to have boosted government spending by about 5%, assuming other expenditure was not cut back to accommodate this.

The amount of campaign spending by individual candidates and political parties can only be very roughly estimated – much less its macroeconomic impact. Anecdotal evidence suggests that the level of spending in support of individual candidates for election to the national parliament was anywhere between a few million and 5 billion rupiah, and there were more than 11,000 candidates competing for the 560 available seats (Kompas, 31 October 2008). If each candidate spent, say, Rp 500 million, then the total of such spending would have been about Rp 5.5 trillion. In addition, more than 110,000 candidates competed for approximately 1,200 seats at the provincial level and approximately 1.5 million candidates for about 15,700 seats at the district and municipality levels.Footnote3 Though they did not spend as much on average as candidates at the national level, collectively the amount spent in these campaigns would have been enormous. It is difficult to know the extent to which this would have been a net addition to private sector spending, however. On the one hand, individuals and firms may have sacrificed other spending to contribute to election campaigns. On the other, they may have cut back their normal spending because of concerns about the GFC, in which case campaign spending would have tended to offset this.

We take the view that this election-related spending, particularly in Q1 2009, softened the impact of the GFC on households and, together with the stimulus package and direct cash transfers, even helped to raise the incomes of the poor. The latter benefited directly or indirectly from the provision of goods and services for various election campaign activities, as well as from direct cash payments made to individuals who participated in campaign activities in the hope of securing their votes.

Whatever the impact of the elections on macroeconomic performance in the first half of 2009, the debate more recently has been about whether the economy has been recovering from the impact of the GFC since mid-2009. Export performance and the resumption of foreign portfolio investment – plus the fact that other Asian economies are beginning to bounce back – have led many to argue that Indonesia has indeed been on the path of recovery (World Bank Citation2009a; Gunawan and Arman Citation2009). Others, including the present authors, take the more conservative position that, while the impact of the GFC on Indonesia seems to have peaked, considerable uncertainty remains. Data for the fourth quarter will be needed to confirm whether the economy has been on the path of recovery in the second half.

Economic growth and the sectoral outlook

The rate of quarterly year-on-year GDP growth continued its moderate decline, to 4% in Q2 2009 (). The main expenditure category contributing to this outcome was government consumption, which recorded double-digit growth rates for the four quarters through Q2 2009. Private consumption was also important, growing at a reasonably healthy 4.8% in the year to Q2 2009, down from a peak of 6% in the first quarter. This may be an indication that campaign spending for the presidential election had a smaller impact on households than that for the legislative election.

TABLE 1a Components of GDP Growth (2000 prices; % year on year)

The most alarming sign is the decline in the growth of investment spending, which was only 2.7% in Q2 2009 compared with 12.0% a year earlier. Within this category, growth of construction spending remained healthy; but growth of investment in machinery and equipment turned strongly negative, and that in transport fell sharply from around 40% in the second half of 2008. This does not augur well for the future growth of various sectors, particularly manufacturing. Two factors in particular probably played an important role in inhibiting investment: the reduced availability of funding world-wide as a consequence of the GFC; and the adoption of a wait-and-see approach in relation to the elections (Bank Indonesia Citation2009).

Turning to GDP growth by sector, we see that non-tradables have continued to grow far more rapidly than tradables, but also that the growth rates of both have declined markedly from their levels in mid-2008. The manufacturing sector continues to be of significant concern, growing by only 1.8% in the year to Q2 2009 (if petroleum and gas manufacturing are excluded). Most manufacturing sub-sectors contracted in the year to Q2 2009, except for food, beverages and tobacco (16.8%), paper and printing (3.9%) and fertilisers, chemicals and rubber (2.8%). Growth of the food, beverage and tobacco sub-sector has been high since Q4 2008, reflecting the increase in household incomes caused by election campaign spending. Campaign activities also generated demand for products of the textiles, leather products and footwear sub-sector, but export demand fell at the same time. Since around 45% of the output of this sub-sector was exported before the GFC, its recent growth has been relatively low. The paper and printing sub-sector contracted in 2008 but then began to expand in Q1 2009 – probably because of increased use of its products for the election.

The mining sector grew somewhat more rapidly than in 2008, though much more slowly than the economy as a whole. Its expansion mainly reflected increased activity in Eastern Indonesia – not so much in coal production in Kalimantan, as many observers had expected, but more as a consequence of the recovery of Free-port's operations in Papua from a low level in the previous year (Reuters, 21 July 2009).

All components of the non-tradables sector exhibited healthy growth in the year to Q2 2009, with the exception of trade, hotels and restaurants. The communications sector continued to grow at high double-digit rates, driven for several years by the increasing popularity of mobile phones. Utilities have also been growing rapidly, mainly because of the expansion of city gas supply networks as the government tries to encourage households to switch to this fuel.Footnote4 Whether this rapid expansion can be sustained is open to doubt, however. It is not clear that the price paid by households is sufficient to cover the full cost of supply, suggesting that the gas company (Perusahaan Gas Negara, PGN) will continue to rely on subsidies, as is the case with the electricity supplier (Perusahaan Listrik Negara, PLN). Eventually the government is likely to become unwilling to fund increases in this subsidy, making continued expansion difficult.

Growth of the trade, hotels and restaurants sector has declined significantly over the last three quarters, becoming slightly negative in Q2 2009. This has largely been the result of negative growth in wholesale and retail trade. The hotels sub-sector expanded quite slowly in the year to Q2 2009 (2.8%), but restaurants output grew rapidly (by 9.9%), probably as a consequence of the elections. The transport sector rebounded strongly from negative growth in the latter half of 2008 to reach 6.4% in Q2 2009, owing mainly to a resurgence in air transport.

As argued in the previous survey, focusing on year-on-year growth rates at a time when both external and internal circumstances have the potential to cause rapid deterioration in the economy runs the risk of failing to notice significant changes in performance. therefore presents quarter-on-quarter growth rates, adjusted for seasonality. On this basis, we can see that private consumption surged in Q1 2009 but then fell back to a surprisingly low level in the second quarter. The reverse is true for government consumption (not seasonally adjusted), which has exhibited extraordinarily high volatility. As predicted by Kuncoro, Widodo and McLeod (2009: 159), the huge decline in the first quarter was followed by an increase almost as large in the second, providing a considerable stimulus to the economy.

TABLE 1b Components of GDP Growth (2000 prices; seasonally adjusted; % quarter on quarter)

The quarterly figures show an improvement in all categories of investment spending growth in the second quarter, providing some additional support to those who argue that the economy is already recovering from the impact of the GFC. Further evidence of this can be seen in the return to positive growth of both exports and imports in Q2 2009, and from inspection of the merchandise trade data. and present monthly data for the major categories of exports and imports, converted to three-month rolling sums, and expressed in index form. There is a clear general pattern of decline starting from the fourth quarter of 2008 and running through to about April 2009, with a significant and widespread recovery subsequently. Although absolute levels remain well below their previous peaks, and continuation of the recent trend cannot be guaranteed, the outlook here provides some grounds for optimism.

FIGURE 3a  Exports
($ values, 3-month rolling sum, July 2008 = 100))

FIGURE 3a  Exports ($ values, 3-month rolling sum, July 2008 = 100))

FIGURE 3b  Imports
($ values, 3-month rolling sum, July 2008 = 100)

Source: CEIC Asia Database.

FIGURE 3b  Imports ($ values, 3-month rolling sum, July 2008 = 100) Source: CEIC Asia Database.

Returning to the national income accounts data in , we also find grounds for optimism in the evidence that manufacturing (excluding petroleum and gas) grew more rapidly than the economy as a whole in the first two quarters of 2009. Likewise, the trade, hotels and restaurants sector bounced back in the second quarter from a significant decline in the first. In short, on the basis of the most recent quarterly and monthly data, the near-term future of the economy seems promising. Nevertheless, we caution that it is too soon to be sure that these new trends can be sustained.

Regional growth

Since the sectoral composition of output differs widely across the regions of Indonesia, it is of interest to look at economic performance from a regional perspective. The impact of the GFC has been felt more strongly in Kalimantan and Sumatra than in other regions. To illustrate this, we focus on growth data for the three quarters to Q2 2009 in . Of the seven regions shown, Papua has recorded extraordinarily rapid growth, driven largely by an astonishing expansion of output from the dominant mining sector, but also by significant growth of manufacturing and services. For the small and less advanced Maluku and Nusa Tenggara regions, the impact of the GFC seems to have been relatively modest, with the former recording growth of 5.9% in the year to Q2 2009 and the latter 4.2%. Beyond these brief observations, the following discussion focuses primarily on the four remaining large regions: Kalimantan, Sumatra, Java-Bali and Sulawesi.

TABLE 2 Regional Economic Growth (2000 prices, % year on year)

The poorest performing region most recently has been Kalimantan, whose gross regional domestic product (GRDP) growth rate fell to 1.1 % in the year to June 2009, from 7.2% a year earlier. Sumatra too seems to have suffered significantly, with a decline to 2.8%, from 6.1% a year before. Sulawesi's growth rate has declined, although from a high level in 2008. Reflecting its dominance in the economy, growth in Java-Bali has declined to roughly the rate for Indonesia as a whole.

As was the case for non-tradables growth nationally, services growth in the regions has been much more rapid than growth of agriculture, mining and manufacturing: in all regions other than Papua, services continued to grow considerably faster than GRDP. The growth of agricultural output fell to quite low levels in Q2 2009, and became strongly negative in Kalimantan – mainly because of negative growth of the forestry sub-sector, which is facing a decline in forest stocks. In the case of Sumatra, both the food crop and forestry sub-sectors held back agriculture as a whole. The slow growth of food crop output was probably not due to the GFC, but simply reflected unusually high output levels in the previous year; that is, the slowdown in the last three quarters was merely a movement back toward the long-term average growth rate.

There are wide differences in the growth of mining across major regions. Mining output has been declining in Sumatra for some time, and even more rapidly in Sulawesi, although Q2 2009 saw a return to expansion in the latter. In Sumatra, the negative growth was attributable mainly to declining gas production in Aceh as the reserves there become depleted (World Bank Citation2009b: 1). In Kalimantan, the decline in growth over the last three quarters reflected a fall in the performance of the non-oil and gas mining sector, probably due to reduced demand for coal during the GFC.

Manufacturing has been declining significantly in Kalimantan for the last three quarters, reflecting negative growth of the wood-based industries (excluding pulp and paper) and of oil and gas refining. The wood-based industries have been affected by the declining availability of good-quality wood from Kalimantan's forests, while refinery output has fallen in response to a slowing of domestic and international demand. The growth rate of manufacturing has also slowed in Java-Bali during the same period, and this has been a major contributor to its low growth overall. The disappointing performance of the manufacturing sector in Java and Sumatra was probably caused by a fall in export demand in response to the GFC. Increased domestic consumption during the election campaigns period was not sufficient to offset the impact of the downturn in the global economy. On the other hand, Sumatra's manufacturing does not seem to have been significantly affected by the GFC, and the growth of manufacturing output has accelerated to quite a high level in Sulawesi.

Balance of payments, capital market and exchange rate

One cause for optimism that the economy is already on the path of recovery is the balance of payments (). After three quarters of small deficits, the current account returned to a sizeable surplus in the first two quarters of 2009. Although exports remain well below their levels during most of 2008, the decline in average imports in the first half of 2009 has been even greater, such that the merchandise trade balance has been restored to its 2007 average. The values of oil and gas exports and imports have fluctuated quite considerably in line with big swings in world prices, but they have tended to move in the same direction, so the difference between them has been relatively stable. The recent strengthening of the merchandise trade balance is due mainly to the non-oil and gas component: this item was three times as large in Q2 2009 as in the last quarter of 2008. Considerable volatility is evident in the financial account, with no clear pattern emerging. Portfolio investment, which turned negative in Q3 2008, and strongly so in the fourth quarter, bounced back in the first half of 2009 to levels closer to those of 2007 and early 2008. Thus the large negative overall balance recorded in Q4 2008 was almost totally reversed in the next quarter.

TABLE 3 Balance of Payments ($ billion per quarter)

Share prices on the Indonesian Stock Exchange Index have continued the steady climb that began in March 2009 (though at a somewhat slower rate since August), reflecting investor confidence in the near-term economic outlook (). The continuous strengthening of the rupiah during the same period also suggests that investors are willing to restore or increase their exposure to Indonesian assets. Overall, it would appear that the business community is reasonably satisfied with the government's handling of macroeconomic policy, and with the outcome of the elections. That said, Indonesia's economic outlook for the near future still remains somewhat uncertain. Foreign direct investment in Q2 2009 was negligible, while other foreign investment became strongly negative. And although the balance of payments is strong, exports are still down somewhat on the levels recorded a year ago. Imports are even more depressed than before the onset of the GFC, although most major categories have been on an upward trend since early in 2009. At best, cautious optimism seems justified.

FIGURE 4  Composite Stock Price Index (CSPI) and Exchange Rate

Source: Indonesia Stock Exchange; Pacific Exchange Rate Service.

FIGURE 4  Composite Stock Price Index (CSPI) and Exchange Rate Source: Indonesia Stock Exchange; Pacific Exchange Rate Service.

Inflation

The rate of inflation of consumer prices has fallen steadily over the last 12 months from over 12% to below 3% () for the first time since 2000. Successive interest rate adjustments by Bank Indonesia (BI) have succeeded in gently lowering the rate of growth of the money supply (represented by currency in circulation in ), resulting in the expected parallel reduction in inflation. Until very recently, inflation was falling more rapidly than the interest rate on 30-day BI Certificates (SBIs), so the real SBI rate has been rising steadily, peaking at almost 4% p.a. Another consequence of this deft management of monetary policy is the already noted strengthening of the external value of the currency during the same period. Given the sensitivity of the public to rapidly rising prices, SBY would appear to owe a significant debt of gratitude to the central bank for bringing inflation under control in the lead-up to the presidential election.

FIGURE 5  Monetary Policy and Inflation(% p.a.)

Source: CEIC Asia Database.

FIGURE 5  Monetary Policy and Inflation(% p.a.) Source: CEIC Asia Database.

The interesting question now is how BI will respond to its own success in bringing inflation down to this low level. On such occasions in the past, it has succumbed all too readily to the argument that, since inflation is low, it can afford to reduce interest rates significantly. The predictable result has been that money supply growth has accelerated, and the inflation rate has broken away from its target range. BI's skill in managing monetary policy in the face of the threat posed by the GFC over the last year or so provides reason for optimism that this time it will manage its interest rate instrument so as to maintain money growth at about the 8% p.a. level achieved during the third quarter.Footnote5 If so, there should be no difficulty in holding inflation below 5% as the incoming government settles in.

Employment, household income and poverty

Despite the relatively modest impact of the GFC, economic growth has declined somewhat, while the labour force has continued to grow at about 2% p.a. This has given rise to concern about the impact of the economic slowdown on employment, household income and poverty. shows that unemployment continued to decline between August 2008 and February 2009 – the period when the GFC was having its strongest impact on Indonesia – falling from 8.4% to 8.1%. The concern is that if the early signs of recovery turn out to have been misleading and growth begins to decelerate again, it is still possible that the GFC could cause a reversal of this downward trend in unemployment.

TABLE 4 Composition of the Labour Forcea (%)

Among those working, the proportion employed in the formal sector has been relatively steady since August 2007. It is very surprising that in the six months to February 2009 when the economy – particularly the manufacturing sector – was slowing down, there was no reduction in the proportion of formal sector employees. A possible explanation is that firms were already responding to various tax cuts and incentives in the government's fiscal stimulus package, since one eligibility requirement for some of those incentives was that the firm should promote employment-that is, avoid laying off workers.

The proportion of casual workers was also steady in the year to February 2009. Employing casual workers gives employers relative flexibility, as they can respond to an economic downturn by offering them fewer working hours per week if necessary. It is possible also that the social infrastructure activities that are part of the stimulus package had begun to have an impact by February 2009 through the creation of casual employment opportunities, although the size of this part of the package was small (less than 1% of the total).

The proportion of self-employed workers fell slightly in the six months to February 2009, returning to its level a year earlier. There was a comparable increase in the proportion of unpaid family workers, which more than offset the small decline in unemployment noted above. This increase perhaps gives some cause for concern, since becoming an unpaid worker in a family business might be little better than becoming unemployed. Average returns to individuals in family enterprises are likely to be depressed if more family members have to share the fixed or declining amount of work available. In turn, this could raise the level of poverty.

At the national level, in both rural and urban areas, real household incomes per capita were higher in March 2009 than a year earlier (). At the regional level, however, this was not the case everywhere. Average incomes declined in urban areas in Nusa Tenggara, and in rural areas in Sulawesi, Maluku and Papua.

TABLE 5 Household Income per Capitaa (Rp ‘000, 2008 prices)

We estimated the relationship between the change in household income per capita between 2008 and 2009 and the income level in 2008 (both in 2008 prices), controlling for characteristics of household heads – gender, age and educational attainment – as well as for the size of the household and whether it was in a rural or an urban area. The estimated coefficients indicating the change in income given the initial income are significantly negative at both the national and sub-national levels (). Thus the lower the income in 2008, the larger the increase in income in the following year. This suggests that the level of poverty may have fallen even in regions where average household incomes declined.

The national poverty figure was lower in March 2009 than a year earlier (): the GFC therefore did not increase the percentage of people living below the poverty line set by the central statistics agency (Badan Pusat Statistik, BPS). At the sub-national level also, poverty figures for March 2009 were lower than those for March 2008 in all regions except Papua, where an increase in poverty in rural areas more than offset a further decline in the already low level of urban poverty.

TABLE 6 Regional Poverty Levelsa (%)

Based on the above observations of the dynamics of the labour market, household incomes and poverty, we propose the following interpretation. The stimulus measures, particularly the tax cuts and social infrastructure projects, together with various kinds of spending related to the elections, helped to maintain employment levels in the formal sector and the share of casual employees in the workforce in the face of the GFC.Footnote6 In combination with the disbursement of direct cash transfers to the poor in early 2009 and cash paid by parliamentary candidates to voters, particularly the poor, this led average household incomes to increase in most regions, and the increase was higher in most areas for poor people than for the population as a whole in the year to March 2009. This is consistent with the observation of widespread declines in poverty, except in rural Papua. On this interpretation, the GFC, the stimulus package, the direct cash transfers to the poor, and election campaign spending have combined to create a mechanism of income redistribution in favour of the poor, except in rural Papua.

SBY'S FIRST 100 DAYS

Following the announcement of their election victory, President SBY and his new vice president, Boediono, were quick to announce a set of socio-economic targets to be achieved during SBY's second term in office (Yudhoyono and Boediono Citation2009). The quantitative targets for economic development and welfare improvement are as follows:

  • the rate of economic growth should rise to approximately 7% annually by 2014 (the end of SBY's second term);

  • unemployment should fall to 5–6% by 2014;

  • the proportion of people living in poverty should fall to 8–10% by 2014; and

  • the annual inflation rate should be in the range 3–5% throughout.

To achieve these targets, the president rightly emphasised the importance of implementing sound macroeconomic policies.

In addition, the leaders specified a set of qualitative socio-economic objectives:

  • to improve access to education so as to increase literacy and educational attain ment more generally;

  • to improve access to health care facilities so as to lower the rates of maternal and infant mortality and increase life expectancy;

  • to establish better food and energy security;

  • to maintain environmental quality in both urban and rural areas;

  • to develop better infrastructure; and

  • to strengthen medium and small enterprises.

In thinking about the quantitative targets, it is worth recalling a similar set of targets set by SBY for his first presidency (2004–09), none of which was achieved (Kuncoro, Widodo and McLeod Citation2009). Economic growth rates approached but never reached the 7% target (averaging 5.7%), and the period has been categorised as one of ‘jobless growth’ (Manning and Roesad Citation2007), in which both the unemployment and poverty targets were missed.

To avoid similar disappointment in SBY's second term, his government will need to give stronger emphasis to policies that enhance economic growth and, in particular, encourage ‘employment-friendly’ growth. Indonesia's experience during the last five years with economic growth, unemployment and poverty is shown in . With population growth of about 1.3%, it can be seen that unemployment declined when GDP growth exceeded 5.5%. Poverty then began to decline as growth accelerated to above 6% and unemployment fell further. On this basis, and given that GDP growth currently is only about 4%, we argue that reducing unemployment and poverty to levels of 5–6% and 8–10%, respectively, by 2014 will require the achievement of 7% or higher growth much earlier than 2014, and preferably by 2010. Alternatively, the government will need to make a greater effort to achieve growth of a kind that is more labour intensive.

FIGURE 6  Annual GDP Growth, Unemployment and Poverty under the First SBY Administration (%)

Source: CEIC Asia Database; BPS (Citation2009).

FIGURE 6  Annual GDP Growth, Unemployment and Poverty under the First SBY Administration (%) Source: CEIC Asia Database; BPS (Citation2009).

In addition to setting out their overall goals for the next five years, SBY and Boediono have focused on a strategy for the first 100 days of the new administration, knowing from past experience that the media can be expected to devote a good deal of attention to evaluating the government's performance during this early period. Accordingly, they put together a small team in August to provide basic economic policy guidance for both the first 100 days and the next five years. The team collaborated with various government departments and with international donors in formulating its recommendations. Based on interviews with various individuals who have interacted with the economic team, we understand that the general strategy for the first 100 days will be as follows.

The emphasis will be on quickly implementing several small reform projects that are not politically sensitive. The focus will be on ‘low-hanging fruit’, so as to ensure success and demonstrate to the general public and the rest of the world that the new government is serious about conducting reform. By generating these quick success stories, the government hopes to create a perception that it has the will and the capacity to tackle reform more generally. It believes that such perceptions matter: that the positive impact resulting from these small reform projects is likely to create a snowball effect, making it easier to implement much larger and more sensitive reform projects subsequently. Besides undertaking some small reforms quickly, the team intends the government to initiate at least one large project within the first 100 days, such that it is fully planned and its financing secured during this time-frame. This is designed to demonstrate that SBY and his new cabinet are well capable of implementing mega projects. One possibility under consideration is the construction of a trans-Java highway.

The initial reforms extend to the areas of geographical infrastructure, soft infrastructure and social infrastructure. The thinking behind them is that, while the normal level of global demand for goods and services may not recover for some time yet, production for the domestic market can be encouraged by allowing goods and services to move more cheaply and freely between various parts of the country. The benefits of this accelerated growth would then be expected to spread widely throughout the country.

In the area of geographical infrastructure, the plan is to improve inter- and intra-island connections through better port services and other transport systems. This includes improving the quality of inter-island shipping, ports, roads and bridges. Improving soft infrastructure involves reforming regulations so as to reduce the bureaucratic obstacles to inter- and intra-island economic links. Examples include the reform of permit and licensing systems in the field of transport, and the resolution of private and public land tenure problems related to roads and other transport facilities. The improvement of social infrastructure focuses on enhancing the ability of the poor to engage in domestic market activities through schemes such as the National Program for Community Empowerment (Program Nasional Pemberdayaan Masyarakat, PNPM) and the Schools Operational Assistance (Bantuan Operasi Sekolah, BOS) scheme.

In our view, this ‘first 100 days’ strategy of committing to a few non-sensitive reforms that face little opposition, while avoiding or delaying implementation of important reforms that face strong opposition from particular interest groups, is hardly likely to create a perception that the new government is serious about undertaking reform. Furthermore, this strategy risks failing to do what is necessary to achieve the targets of 7% growth, 5–6% unemployment and 8–10% poverty. For example, it has been argued that one of the key factors constraining both the growth of the manufacturing sector and the achievement of more employment-friendly growth is the current labour law. According to this argument, the law needs to be revised (Manning and Roesad Citation2007), but the first SBY administration backed away from this because of strong political opposition to such a move. Regardless of whether other, ‘easy’, reforms are implemented within the first 100 days, this opposition will not disappear. Likewise, in the mining sector, problems with land tenure and conflicts between the forestry and mining ministries and between the state and local populations have delayed for many years the opening up of new mining projects that would benefit not only the firms in question but also the local government and people (Resosudarmo et al. Citation2009). To deal with such reforms and problems, the government may need to overcome strong resistance from the bureaucracy, the business community and the general public. This will require much more than the implementation of a few ‘quick and easy’ reforms in other areas. What is called for within the first 100 days, therefore, is a clear commitment to undertake these important but difficult reforms as quickly as possible.

The idea of initiating a mega construction project within the first 100 days gives cause for concern. The first SBY administration found it extremely difficult to obtain private sector financing for large infrastructure projects, and there is no obvious reason to believe that this problem can now be easily overcome. If it cannot, the government would need to rely on its budgetary resources or on additional borrowing.

illustrates the difficulty of funding a huge infrastructure project from the budget. The level of subsidies is still very high (accounting for about 16% of total expenditure in 2008), and the experience of the first SBY administration is that it is extremely difficult politically to cut back these subsidies. In addition to this, about 11 % of budget funding needs to be devoted to non-discretionary interest payments on the government's accumulated borrowings, and the law requires it to allocate at least 20% of the budget to education.Footnote7 Against this background, it becomes clear why the budgetary allocation for capital expenditure is only 9–10% of the total. It will not be possible to initiate a mega construction project in the first 100 days unless some way around this financing constraint can be found.

TABLE 7 Budget Expenditure Plans and Realisation

A reminder of the difficulty of getting things done quickly is provided in the data for realisation of the 2009 budget through to July (). In a year in which it was highly desirable to implement a quick fiscal stimulus, it is evident that the bureaucracy again failed to overcome the obstacles to quick disbursement of funds in several important expenditure categories. By the end of July, 50–60% of planned spending for the year should have been achieved, but for capital expenditure the figure was less than 30%, for spending on goods and services a little over 40%, and for several categories of transfers to the regions only 22–34%. It is well known that the obstacles to the smooth disbursement of government spending over the fiscal year are deeply entrenched. The implementation of some easy reforms during the first 100 days will not suffice to overcome them.

INFRASTRUCTURE DEVELOPMENT

The slow progress in infrastructure development since the 1997–98 financial crisis is both widely known and of concern to the SBY administration. In the years after the crisis, the government had limited capacity to finance infrastructure projects because of the need to service the huge debt resulting from the bail-out of failed banks. This prevented it from responding adequately to this fundamental pre-requisite for sustained economic development (Kong and Ramayandi Citation2008). Since government has played the major role in infrastructure investment in the past,Footnote8 its failure to continue doing so has put the maintenance of high economic growth at risk.

More recently, high world oil prices provided an opportunity to overcome this fiscal constraint, but rather than remedying the lack of infrastructure spending the government chose to dissipate this windfall in increased domestic subsidies to fuel consumption. Meanwhile, it held a number of infrastructure summits, and launched an infrastructure reform package, the key feature of which was the encouragement of domestic and foreign private sector involvement in infrastructure development (Lindblad and Thee Citation2007).

Within the last year, the need for a fiscal stimulus to mitigate the effects of the emerging global financial crisis provided a new opportunity to accelerate investment in infrastructure. The government announced a large fiscal stimulus package in January 2009, which included additional infrastructure spending amounting to over Rp 10 trillion – later boosted to more than Rp 12 trillion (Kuncoro, Widodo and McLeod Citation2009: 159). While only 10% of the additional infrastructure budget was spent during the first half of 2009 (World Bank Citation2009a), it was expected that this spending would soon accelerate.

Although infrastructure investment by the private sector was relatively low after the previous crisis-even declining somewhat in 2005 – more recent data show some improvement. The total amount of private participation in Indonesian infrastructure projects recorded in the World Bank's Private Participation in Infrastructure database increased sharply from just $1.3 billion in 2005 to over $5 billion in 2007 ().

FIGURE 7  Private Participation in Infrastructure Projects in Indonesia a ($ million)

a Private participation in water and sewerage infrastructure has been negligibly small. These data have been omitted from the chart.

Source: World Bank, Private Participation in Infrastructure database.

FIGURE 7  Private Participation in Infrastructure Projects in Indonesia a ($ million) a Private participation in water and sewerage infrastructure has been negligibly small. These data have been omitted from the chart. Source: World Bank, Private Participation in Infrastructure database.

There has also been a promising change in the composition of private sector participation. There was almost no private participation in transport infrastructure projects in the first few years of this century. Private sector involvement in infrastructure was dominated by the telecommunications industry. But in 2006 and 2007 both the transport and energy sectors also became targets for private investment. About $1 billion of private investment in transport was recorded in 2007, along with almost $500 million in energy projects.

Another encouraging development is the recent improvement in Indonesia's ranking in the infrastructure index of the Global Competitiveness Report, published annually by the World Economic Forum (WEF).Footnote9 Although Indonesia's rank is still low, it has risen in the last three years, from 91st to 84th among the 133 countries evaluated. The Forum also conducts an annual survey that asks respondents to identify the most problematic factors in doing business in the country in question. The proportion of respondents who viewed inadequacy of infrastructure as the biggest problem in Indonesia fell from 20.5% in 2007 to just 14.8% in 2009.

These encouraging developments must be seen in a longer-term perspective, however. Many observers have voiced concern about the low level of investment in infrastructure since the Asian financial crisis. Before 1997–98, infrastructure investment accounted for more than 5% of GDP, but it has fallen to only about 2% in recent years (Lindblad and Thee Citation2007). We can get some idea of the magnitude of the problem by focusing on road infrastructure over the last two decades ().

TABLE 8 Length and Density of Roads Before and After the 1997–98 Crisisa

Development of the road network during the decade before the 1990s crisis was substantial. Over the period 1987–98 the total road network grew by about 4.1% annually, and paved roads by an even more rapid 4.9%. Thus total road density – the length of roads per capita – grew by 2.6%, while the average quality of roads also improved. The high rate of economic growth during this period no doubt owes a great deal to the rapid development of road infrastructure.

After the 1997–98 financial crisis, however, the growth of the road network slowed so much that it failed to keep pace with population growth. The length of paved roads grew by just 0.4% annually from 1999 to 2006, and that of total roads by only 0.8%. As a result, Indonesia's road density contracted by 0.5%. Just as the expansion of the road network is likely to have contributed to high growth before the 1997–98 crisis, this contraction seems likely to have held back economic growth since then. The records also show that the length of paved roads actually declined during 2004–06, mainly as a consequence of poor maintenance (BPS Citation2008).

Serious deterioration in other indicators of infrastructure development relative to the pre-crisis period has also been evident. Annual growth in per capita electricity consumption between 1999 and 2006 (5.3%) was only half that for 1987–98 (10.8%). This is worrying, given that Indonesia's electricity consumption in 2004 was only one-third of the Southeast Asian average (Moccero Citation2008: 13). Growth in the number of fixed-line telephone subscribers per 100 people also decelerated in the years following the crisis, from 16.4% annually in 1987–99 to 11.4% in 1999–2006.Footnote10

The stagnation of infrastructure development over an extended period casts doubt over the possibility of Indonesia achieving high and sustained economic growth in the future. It is unlikely that the government's target rate of 7% annual growth by 2014 can be achieved unless there is a dramatic improvement in the level of investment in infrastructure. Although there have been some signs of improvement in recent years, there is still a long way to go before Indonesian infrastructure investment returns to pre-crisis levels.

CLIMATE CHANGE AND ITS CHALLENGES

Two years ago the signatories to the Kyoto Protocol gathered in Bali for the 2007 United Nations Climate Change Conference, where they launched negotiations for stronger action to reduce climate change. The conference culminated in the adoption of the Bali Road Map and the Bali Action Plan, which chart the course for a new negotiating process to be finalised at the UN Framework Convention on Climate Change conference in Copenhagen in December 2009. Thus December 2009 marks an important moment in the history of climate policy, because it is hoped that the nations convening in Copenhagen will be able to agree upon a post-Kyoto global framework for tackling climate change.

In 2009 there have been new developments in many aspects of climate change thinking that have potentially important implications for the Indonesian economy. First, there is an increasing awareness that Indonesia has a bigger responsibility to the international community than was previously thought. Various reports have noted that Indonesia is one of the world's largest contributors to carbon dioxide (CO2) emissions, if emissions from deforestation and forest degradation are included. Such emissions account for 55–85% of Indonesia's total CO2 emissions. Although it is very difficult to estimate emissions from deforestation, forest degradation and peat fires with accuracy, most informed observers are convinced that they are considerable. Taking into account the various uncertainties, the amount seems to be between 500 and 2,500 million tonnes (Mt) of CO2 per year – bringing Indonesia's total emissions to between 900 and 2,900 MtCO2 per year, although this range is still subject to debate. By comparison, the estimates for the US and China are around 6,500 and 5,000 MtCO2 per year, respectively (Sari et al. Citation2007; IFCACitation2008; Jotzo Citation2009). Although emissions from the energy sector are small relative to those from deforestation, future growth in annual emissions is likely to be driven mainly by increased demands on the energy sector as the economy grows, since emissions from deforestation and forest degradation are limited by the remaining forest area (Resosudarmo et al. Citation2008).

In terms of CO2 emissions per capita, Indonesia's level is still low compared with that of many developed countries, except if the highest estimates of emissions from deforestation and forest degradation are accurate. According to the Climate Analysis Indicator Tool database, Indonesia ranked 18th in per capita emissions in the early 2000s, provided that emissions from land-use and forestry are included.Footnote11 Nevertheless, international attention is focused on total emissions, and Indonesia was ranked 4th in the world in the early 2000s on this measure. Even when emissions from land-use change and forestry were excluded, it still ranked as high as 16th in the mid-2000s. Accordingly, there is pressure on Indonesia to reduce emissions from deforestation and forest degradation in the short term, and to use cleaner sources of energy and improve energy efficiency in the longer term.

The government now purports to take climate change mitigation seriously. In this year's G20 meeting in Pittsburgh, President Susilo Bambang Yudhoyono announced that Indonesia had decided on a national climate change action plan that ‘will reduce our emissions by 26 per cent by 2020 from BAU (Business As Usual)’, and that, with international support, Indonesia ‘could reduce emissions by as much as 41 per cent’ (Agence France-Presse, 29 September 2009). Much of the potential for reduction (more than 80%) relates to forestry, peat-land and agriculture,Footnote12 where Indonesia makes its greatest contribution to global warming.Footnote13

A cut of 26% constitutes a far more ambitious target than other developing countries have contemplated. It is comparable with some of the most ambitious targets the rich nations are considering for themselves, and there is good reason to question whether this proposal has a strong foundation. First, there is still a great deal of uncertainty as to the actual amount of Indonesia's emissions, especially from land-use change and forestry; second, the policies that would be needed to reduce deforestation and switch to cleaner sources of energy are likely to be highly complex; and third, the overall cost of doing so is very uncertain. It is important for Indonesia to consider carefully all these aspects of reducing its emissions before making such promises if they are to be taken seriously. Despite all these complexities, however, we commend the statement by President Yudhoyono, because it indicates that Indonesia cares about, and is willing to contribute to, resolving the important global issue of climate change mitigation.

Adaptation is another aspect of the response to climate change, alongside mitigation. The importance of climate change adaptation for Indonesia became more obvious when a number of new studies revealed that it is among the countries most at risk. In April 2009, the Asian Development Bank (ADB) released its long-awaited regional review of climate change (ADB Citation2009). The review concluded that Southeast Asia, in which Indonesia is the largest country, is highly vulnerable to climate change. According to the report, the impact of climate change is already being felt in the region: the mean temperature increased by 0.1–0.3°C per decade between the early 1950s and the early 2000s; rainfall trended downward between the early 1960s and the early 2000s; and sea levels rose by 1–3 millimetres per year in the latter period. Indonesia's long coastline makes it particularly vulnerable to sea-level rise, as millions of its people live in coastal zones – many of them in densely populated cities. It is estimated that a one-metre sea-level rise could displace around 10 million people in Indonesia (Dasgupta et al. Citation2007).

The impact of climate change is not limited to the effects of rising sea levels, however. It includes floods and droughts, the occurrence of more extreme climate events, increasing water scarcity, and more widespread disease among humans. Although the incidence of these effects may vary across the country, they will probably be felt in most if not all parts of Indonesia (Jotzo et al. Citation2009). A high risk of being affected by these changes, and a low capability to adapt, define certain groups of people or areas as being vulnerable to climate change. Based on the Intergovernmental Panel on Climate Change (IPCC) definition, Yusuf and Francisco (Citation2009) devised and calculated an index of climate change vulnerability for 530 sub-national regions in seven Southeast Asian countries.Footnote14 They found that Jakarta is the most vulnerable city in Southeast Asia, and that many other big cities in Indonesia, particularly in Java, are also among the most vulnerable in the region. These cities not only face a high risk from climate change-particularly the risk of sea-level rise – but also are densely populated.

It is important to pay attention to Eastern Indonesia, particularly Nusa Tenggara, Maluku and Papua, which comprise thousands of islands, many of them inhabited. The people living in these areas are among the poorest in the country (Resosudarmo and Jotzo Citation2009) and they are particularly vulnerable to the impact of climate change. Helping them to adapt is likely to be difficult and costly, because these areas are among the most inaccessible in the country.

Despite all this, adaptation is currently not a top priority on Indonesia's policy agenda, for two main reasons. First, appreciation of the seriousness of climate change is not yet widespread domestically, so thus far it has not created much political pressure. Francisco (Citation2008) notes that only 10 of the 116 pages of Indonesia's national climate change action plan are devoted to impact and vulnerability, and just two discuss the adaptation issue (Republic of Indonesia Citation2007). Second, little international funding is available for adaptation purposes compared with the amounts devoted to CDM (Clean Development Mechanism) and REDD (Reducing Emissions from Deforestation and Forest Degradation) activities. Governments throughout Indonesia are eager to be involved in the planned REDD scheme, given its potential to generate funds for development. In contrast, the international community does not see Indonesia as being at the forefront of developing countries in need of significant assistance for adaptation. The current focus of adaptation assistance under the UN Framework Convention is on very low-income countries.Footnote15

Indonesia clearly needs to take action to help its people adapt to the effects of climate change. Considering the large numbers potentially affected and the difficulty of developing an adaptation strategy, this should be a top priority on the climate change agenda. Indonesia should champion this issue at the international level and argue for more international support.

With the Copenhagen meeting approaching, a clear understanding of the extent of Indonesia's vulnerability to climate change should strengthen the government's resolve to help make the meeting a success. It should have all the motivation it needs to extend its efforts beyond mere awareness-raising. As the host of the Bali conference two years earlier, Indonesia has much at stake at the Copenhagen summit, since this is where the Bali Action Plan will come to its conclusion. Although the Bali Action Plan has four important pillars – mitigation, adaptation, technology and financing – the world will probably pay most attention to the key decisions to be made: those concerning the ‘deep cuts’ in emissions. Some important countries have already made promising gestures at the September 2009 G-20 summit. Apart from Indonesia's announcement, the most notable statement came from Japan's prime minister, Yukio Hatoyama, who pledged to cut greenhouse gas emissions by 25% by 2020 from 1990 levels. The Chinese president, Hu Jintao, also promised to put a ‘notable’ brake on his country's rapidly rising carbon emissions by cutting ‘carbon intensity’ – the amount of CO2 generated for each unit of economic output – over the decade to 2020. The US president, Barack Obama, on the other hand, though acknowledging that his country has a lot of catching up to do, by early October had still offered no specific details.

As yet there has been no significant statement from the international community about helping developing countries to adapt to climate change. Indonesia has already announced to the world its intention to act decisively on mitigation. It is to be hoped that the government will also lend its weight to promoting the importance of the adaptation issue in Copenhagen.

Acknowledgements

The authors thank Ditya A. Nurdianto and Abdurohman for their assistance with data collection.

Notes

1The discussion here is based on a presentation by Hal Hill on ‘Southeast Asia and the global financial crisis’ at the Australian National University on 14 October 2009.

2Social expenditure is described as ‘all spending on transfers, in cash or in kind, to members of the population in order to protect them from social risks’ (Government Regulation No. 21/2004). It consists of social compensation assistance, social assistance to educational and religious institutions, and other social expenditure.

3There were also about 1,000 candidates competing for 132 seats in the Regional Representative Council (Dewan Perwakilan Daerah, DPD) in Jakarta.

4For example, the government allocated approximately Rp 100 billion to expansion of the gas distribution networks in Palembang and Surabaya (Kompas, 5 June 2009).

5The sudden downturn in money growth in September 2009 does not represent a change in approach, but rather a spike in the money supply in September 2008.

6This does not preclude the possibility that average working hours declined, particularly in the formal sector.

7The education expenditure is spread among several budget items.

8Government accounted for 60–70% of total infrastructure spending just before the 1997–98 financial crisis (World Bank Citation2007).

9In the Global Competitiveness Report, infrastructure quality is represented by an aggregated index of the quality of road, rail, port and air transport infrastructure and of electricity supply, together with measures of airline passenger carrying capacity and the number of telephone lines (WEF Citation2009: 45).

10On the other hand, this has been more than offset by the rapid increase in the number of mobile phone subscribers.

11It ranked only 108th if these emissions are excluded.

12‘Cost curve fact sheet’, in Dewan Nasional Perubahan Iklim (National Council on Climate Change, DNPI) press release, 27 August 2009.

13A 41% reduction would contribute 5% of the total global reduction needed to prevent global warming of more than 2°C, according to the United Nations Intergovernmental Panel on Climate Change (DNPI press release, 27 August 2009).

14Vulnerability is defined here as the degree to which a system is susceptible to, or unable to cope with, the adverse effects of climate change, including climate variability and extremes. Vulnerability is a function of the character, magnitude and rate of climate variation to which a system is exposed, its sensitivity and its adaptive capacity. Adaptive capacity is defined as the ability of a system to adjust to climate change (including climate variability and extremes), to mitigate potential damage, to take advantage of opportunities, or to cope with the consequences (IPCC Citation2001).

15That is, those whose income per capita is less than $750. (Indonesia's income per capita in 2008 was about $2,250.)

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