Survey of recent developments

Indonesia continues to move forward, albeit slowly. We see this as the defining characteristic of the period under review. There is continued macro-economic improvement, and a more viable system of national government is emerging. These developments help to explain why the economy and the government were able in the first half of 2003 to weather without major disruption two potential international shocks (the Iraq war and the SARS epidemic) and a slowing of the world economy. But serious problems persist and there seem to be systematic limits to the ability of policy makers to create an attractive investment environment. We see this mixed judgment-continued progress, but slowly-as a probable pointer to what lies ahead over the next several years. The electoral cycle is already heating up in preparation for next year's multiple contests. Although not conducive to sound economic policy making, electoral politicking thus far shows little sign of seriously disturbing the economy. Also creating remarkably few ripples is the growing recognition that Indonesia is unlikely to renew its relationship with the IMF at the end of 2003. Fortunately too, thus far at least, Indonesia's new war in Aceh has not had significant economic repercussions. The response to the Bali bombing is a modest boost to national confidence. On the other hand, the out-break of SARS in other parts of East Asia has harmed inbound tourist travel. The overall macroeconomic picture continues to improve. Year-on-year GDP growth of 3.4% recorded in the first quarter of 2003 exceeded many expectations. Public debt is still declining as a percentage of GDP, interest rates and inflation have also fallen and the currency has appreciated. And an important new state finance law lays an encouraging foundation for gradual overhaul of the management of public finance. At the micro level the picture remains troubling. Investment trends continue to be weak, progress in banking recovery is slow, the revised labour law contains only modest improvements from an investor viewpoint and there are signs of creeping protectionism. In the wider institutional environment for business, even though the legal system remains a void and much uncertainty still surrounds the devolution of power to regional governments, important progress has been made in straightening out the basic structure and dynamics of government at the national level. With these changes now largely in place, we can begin to think through the implications of the new framework for economic policy and future performance. We see continued slow progress for Indonesia. In the short term this is satisfactory. But over the longer term, a 3-4% growth trajectory has worrying implications for unemployment, poverty and social stability.