Economy in need of a crisis
When Indonesia fell victim to the currency turmoil in south-east Asia last month, it rapidly became clear that sound macroeconomic fundamentals and competent technocratic management might not be enough to restore foreign confidence. More effort would be needed to convince investors that Indonesia was not about to fall victim to the Thai disease of falling exports, an overbuilt property sector and a financial system riddled with bad debt.
The revelation provided the kind of opportunity that some Indonesian technocrats have been seeking for years: the chance to move forward with deregulation in the non-financial sector. Reformers would love to disentangle the web of monopolies, oligopolies, special deals, licensing arrangements and local levies which push up inflation, reduce efficiency, hike the cost of doing business and regularly push Indonesia towards the bottom of the world corruption tables.
In early August, Saleh Afiff, the coordinating minister for finance and economics, announced that the government would dismantle one of the largest and most entrenched monopolies. Bulog, the state-owned agency which regulates trade and distribution in a wide range of commodities including rice, wheat, sugar and garlic, would lose most of its monopolies. His shock announcement was widely welcomed, but Afiff indicated that the battle for deregulation would be hard fought. Among the many beneficiaries of the distortions in the economy are some of the most well connected and wealthy people in the country, including members of president Suharto’s family.
Reform of the monopolies has been a key suggestion from the World Bank and other aid donors to Indonesia for years. “Indonesia has extensive regulations and restraints on domestic competition that increase the cost of doing business, reduce efficiency and limit economic opportunities, often for the poor,” says the bank’s latest report, issued just before aid donors in July allotted a further $5.2 billion in soft loans to one of its biggest borrowers.
According to the bank, reducing the distortions such as marketing taxes, price controls, cartels and industrial licence fees would make companies more competitive, lower costs to consumers and produce better quality goods. The regulations also act as a continued drag on the poor and are becoming an increasingly important political issue.
There has long been a widespread view among government economic ministers that the distortions are creating serious disparities and economic damage. But the non-financial sector remains virtually untouched, even though deregulation has been a policy priority for more than a decade in Indonesia.
Among the well known Indonesians whose activities would be affected by change are several of the children of Suharto, especially his youngest son Hutomo Mandala Putra and his eldest daughter Siti Hardiajanti Rukmana (Tutut). Others with a strong interest in the status quo include Liem Sioe Liong, Indonesia’s wealthiest man, whose Salim group has accumulated riches on the back of special deals for many years; Bob Hasan, a close Suharto associate who controls a marketing cartel in the timber industry; other big conglomerates such as the Sinar Mas group; and the Indonesian army, which is associated with deals in forestry and agriculture, especially in remote areas of the country. Numerous provincial officials, army officers and ruling party members also benefit from the plethora of regulations, imposing levies and fees on local and foreign businessmen alike.
The battle to cut the costs of all this “rent seeking” activity has been going on for years. Finance minister Mar’ie Muhammed has already made significant progress, piloting a bill through parliament that bans “off-budget” spending and reduces the number of levies, fees and taxes which provincial administrations can impose.
“Last year we discovered that the provincial governments had imposed 3,000 separate levies on business activities,” says Iman Taufik, vice chairman of the Indonesian chamber of commerce. “These have now been cut to 13. But we have been too slow in getting rid of these hidden costs.”
Taufik points to numerous examples. Livestock, for instance, can be competitively raised in the poorer areas of eastern Indonesia, where the government is committed to speeding development to close the big income gap with western areas of Indonesia. But central government regulations determine how many goats, pigs or cattle can be shipped from one part of Indonesia to another. Shipping is restricted to licensed traders who hold a permit and each shipment must be accompanied by a livestock ownership letter.
The permit is reported to cost about Rp4,000 ($1.39) per head. Tax to local government costs about Rp11,000 and the cost of acquiring all the signatures needed on the letter of ownership is about Rp45,000. Together these add about 5% to the cost of each cow. “Eastern Indonesia used to export about 80,000 cattle a year,” Taufik says. “Now it’s only 50,000.”
Sandalwood, one of the original spices which made the pre-independence Dutch East Indies famous, is another case. According to the World Bank, the government has declared all sandalwood trees to be state-owned. It regulates the price at which sandalwood can be sold, a mere Rp200 a kilo compared with Rp11,000 a kilo on the open market. The result is widespread smuggling.
“The incentives are so great that police are reported to have intercepted a group attempting to smuggle sandalwood disguised as a body in a coffin,” the bank reports. “There is no incentive for farmers to plant sandalwood trees, since they don’t own them. Not surprisingly, corruption thrives and the policy has not been successful in preserving sandalwood resources.”
High levies and taxes are often cited as a deterrent to foreign investors planning to manufacture in Indonesia, but the most hard-hit victims of the system are the poor, who are prey to middlemen. This is especially true in rural areas where traders sell goods to farmers and buy their crops, both on credit at interest rates of as much as 1% a day.
If the farmer approaches the local bank in his nearest big town, he may be able to get a loan at the local rate of 2% a month, a considerable improvement on the deal with the trader. But he will probably have to pay an informal fee to the bank official organizing the loan, which will add at least another 3% per month to its cost. The smaller the loan, the bigger, proportionately, is the fee.
And yet despite their constant problems, poor Indonesians still strive to improve themselves. The potential of doing business with them was revealed earlier this year when a consumer credit company, Putra Surya Multidana, listed its shares on the Jakarta Stock Exchange. The company offers loans, mainly for buying motorcycles, to Indonesians who do not have access to banks. From 1993 to 1996 its gross lending grew at an annual rate of 514% to reach almost Rp2 trillion. It made net profits of Rp78 billion in 1996, a return on equity of 42%, and had a bad-debt rate of less than 1%, considerably lower than that of most Indonesian banks.
“Our approach to this grass-roots business combines an intimate knowledge of the communities in which we operate and a highly developed and institutionalized system of incentives [for sales staff],” says president-director Lie Woen Sen. He notes that motorcycles are a basic need for poorer Indonesians, enabling them to get to work or to sell goods and services.
But although the private sector has repeatedly demonstrated its ability to do business even in underdeveloped parts of Indonesia, much activity in remote areas is still controlled by government-linked institutions or is subject to political interference.
Perhaps the most notorious example is the effort in 1990 by Suharto’s youngest son Hutomo, known as Tommy, to take control of the clove industry. Indonesia is the largest clove producer in the world and uses most of the spice in the production of scented “kretek” cigarettes. Indonesia’s two main cigarette producers, the listed companies Gudung Garam and HM Sampoerna, are highly profitable and are favourites with investors.
Tommy secured an agreement from the government which allowed him to market cloves and announced a price to the grower considerably higher than the current market price. Growers, quick to spot an advantage, rushed to grow new trees and to harvest old clove trees which they had previously ignored. Within a year Tommy had accumulated massive stocks which he was unable to finance. Funds of $400 million were extracted from the central bank to help him out, while the cigarette manufacturers were required to buy stocks in advance of their requirements. A complex system was instituted which effectively delayed payments to farmers and persists to this day.
The clove debacle has not discouraged well connected Indonesians from trying to win favourable trading concessions, although increasingly hostile public opinion has begun to limit their success. In 1995 a grandson of the president persuaded the governor of Bali to grant his company a monopoly on alcohol distribution on the island, Indonesia’s premier tourist resort. The company planned to impose a distribution fee on every bottle of beer sold. After strong protests and a temporary ban on supplying Bali by the beer companies, combined pressure by hoteliers, the tourism ministry and the press forced the president to instruct the Bali governor to drop the plan.
Public opinion has been even more critical of Tommy’s latest efforts to get special treatment. Early last year he persuaded the government to favour his plan to manufacture cars in collaboration with Kia Motors of South Korea. Under the deal, Tommy’s vehicle was to be given the status of a “national car” and to be exempt from duties and taxes, enabling him to sell it at half the price of a normal saloon.
To finance the project he got the government to set up a syndicate of state and private banks who are slated to lend him $650 million to pay for the car-making plant. At present the cars, Kia’s Sephia model rebadged locally under the name “Timor”, are being imported fully built from South Korea. But sales have been very weak, owing to the bad publicity and fears that after-sales service and access to spare parts will be poor.
The national car project sparked outrage from competing manufacturers – including Tommy’s brother Bambang who assembles Hyundai cars – which have invested billions of dollars in the local industry. The scheme is the subject of complaints to the WTO by Japan, the US and the EU.
But while some immediate relatives of the president seem determined to look for easy deals, other business associates are no longer so concerned. In June Liem Sioe Liong announced that his corporate empire in Indonesia, based on the listed companies Indocement and Indofood, was to be reorganized and part of the assets sold to QAF, a medium-sized food producer based in Singapore which is 70% owned by Salim.
Currently, Indocement owns 50% of Indofood, a dominant noodle producer whose subsidiary Bogasari Flour Mills has a virtual monopoly on the processing of wheat. Under the new deal, QAF is to buy 51% of Indofood for Rp4.85 trillion. Most of the stake will be purchased from Indocement. Indocement’s shares have languished since Indofood was added to the company in a 1992 internal reorganization of the Salim group. A further small stake in Indofood will be sold to Putera Sampoerna, owner of the HM Sampoerna cigarette manufacturer which already owns 6% of the company.
Salim has denied that the move has anything to do with the announcement that the Bulog monopoly is to be ended. For many years Indofood’s subsidiary Bogasari was the sole flour miller in Indonesia, but recently a second company, owned by Suharto’s daughter Tutut, has also constructed a mill.
Afiff says the move to dismantle Bulog’s monopolies in wheat, soybeans, garlic, onions and sugar was designed not only to boost efficiency but also to stimulate investment to produce commodities for export. Rice will remain under Bulog’s control so that price stability can be ensured. Scarcity or price hikes in the national staple would rapidly cause political problems, says the minister.
Afiff and his colleagues expect fierce arguments in cabinet and strong resistance from vested interests over the deregulation plan, but believe that the current financial instability, caused by currency volatility, leaves Indonesia with no choice but to tackle the distortions and other structural weaknesses in the economy. Tight management of the macroeconomy can no longer do the trick on its own, they say.
Not that economic fundamentals are bad. Indeed, one reason why Indonesia was one of the last south-east Asian countries to fall prey to the currency speculators was the underlying strength of its economy. Growth is forecast at 7.5% for 1997. This is slightly down on the 7.8% recorded in 1996 but still well above government targets. Inflation eased to 5.1% last year and was running at a similar level for this year before the rupiah devaluation in August.
Growth in imports dropped last year from 23% to 10% while exports grew by 9% boosted by strengthening oil prices. The current account deficit at $8.1 billion was restrained to the manageable level of 3.5% of GDP last year but this year is expected to widen to 3.9% of GDP. This compares with a deficit of 4.3% of GDP in the Philippines, 6% in Malaysia and 8.2% in Thailand.
Officials note that a slow-down in export growth has hit most Asian countries as demand in western markets plateaued last year. Export growth in Indonesia was 9.3% in fiscal year 1996/97, compared with 13.3% the previous year. While there is concern about this deceleration, economists note that Indonesia still performs better than most of its competitors.
In electronics exports, where weak demand affected Singapore, South Korea and Malaysia, Indonesia maintained strong growth of 40% in fiscal 1996/97 after a 36% rise the previous year. Electronics exports are now worth $3.9 billion. The recent rupiah devaluation could also boost exports of textiles and garments, footwear and agricultural products but critics say that further measures will be needed to boost trade in these sectors, since competitor countries’ currencies have also depreciated against the dollar.
Foreign exchange reserves have reached almost $20 billion, equivalent to five months’ imports and that level is expected to remain stable. Foreign direct investment worth $29 billion was approved in 1996 and foreign investment reached $7.9 billion in the first quarter of this year, down on the same period last year in advance of the election campaign in June.
Domestic investment in 1996 was valued at Rp100 trillion of which Rp59 trillion was in manufacturing, Rp16 trillion in agribusiness, and Rp9 trillion in property. In the first quarter of this year, domestic investment reached Rp38.6 trillion, up from Rp34 trillion in the same period last year. While manufacturing still accounted for the majority of investment, construction spending shot up to Rp8 trillion compared with only Rp182 billion in the first quarter of last year. Although this category includes power stations and other infrastructure, the sharp rise prompted the central bank to impose restrictions on property-related borrowing in July.
Economists are clear that Indonesia needs to refocus the economy by boosting exports and increasing skills. Higher wages are needed to maintain political stability as Indonesia moves beyond being solely a low-wage economy. Getting rid of the high costs to the economy of levies, bribes, taxes and special deals is the best solution.
Indonesia’s experience of deregulation so far suggests that this analysis is right. In 1985 the country was primarily an oil and gas exporter, with a very protected economy. Following the fall in the oil price in the early 1980s, the government was forced to reorient the economy towards the Asian Tiger model, making manufactured exports a priority.
Two policy changes were key: a lifting of restrictions on foreign investment and a change of attitude to customs, perhaps then the most corrupt part of the public service. The government followed through on incentives for foreigners and effectively sacked the entire customs service, appointing the Swiss firm Société Générale de Surveillance to inspect all imports and exports.
The measures were a triumph. Foreign manufacturers, especially those from other parts of Asia, flocked to locate factories in Indonesia. Exports of manufactured goods and imports of raw materials cleared the ports with ease, reaching almost $40 billion in the last fiscal year, far outstripping oil and gas exports of $12.5 billion.
Emboldened by this success, and unobstructed by vested interests, the government decided to deregulate the financial sector in 1988. That too showed exponential growth, with the stock market attaining a capitalization of $100 billion in less than a decade. Private-sector banks shouldered state-owned behemoths out of the way and controlled 60% of lending by the mid-1990s.
“We have been at the forefront of financial liberalization,” says central bank governor Soedradjat Djiwandondo. “Our currency has been fully convertible for more than 20 years and our capital markets and banking sectors are comparatively advanced. Most countries develop the real sector first and the financial sector later. We did it the other way round. We cannot retract history.”
But history shows that real change tends to happen in Indonesia only when a crisis looms, such as the collapse of oil prices in the 1980s. Will the currency turmoil be enough to prompt fundamental reform in Indonesia when it flies in the face of vested interests with long proven political clout?
This year, responsibility for policing the ports is being returned to the customs department, which is now equipped with better trained staff, computerized procedures and dire warnings that they had better get it right this time. The transfer is being watched closely. If successful it may provide early evidence that Indonesia can make the transition to a fully modernized economy.
Soedradjat and other technocrats believe there is no longer a choice. They regard the currency volatility not just as a little temporary local or regional difficulty which will soon abate, but as a symptom of a fundamental change in the world economy.
“We are now in a much more dynamic environment,” Soedradjat says. “Before, capital flows reflected trade and investment trends. Now, currencies have become a commodity, bought and sold to make profit. Flows of capital are in the trillions of dollars and depend on the market’s perceptions. Nobody’s reserves are big enough to defend inflexible exchange rates. We must adjust to this change.”
The question of succession
Suharto’s highly personalized rule has brought Indonesia stability and prosperity. But at 76 he can’t last forever, and the problem of how and when power passes to a new generation is becoming a nagging worry. Behind the scenes, possible successors are already jostling for position. Here are the men and women to watch
To many Indonesians and most foreign investors, the possibility that a retired army general might want to join an intellectual talking shop for Muslims might not seem an issue of great importance. But this is election time, and coming up early next year is one of the most important political events in Indonesia’s history. Manoeuvring is seriously under way.
In March a body called the People’s Consultative Assembly, which groups the country’s elected members of parliament and a range of appointed dignitaries, will convene to elect a president. For the past 30 years only one candidate has stood for the office and he has always been elected unanimously. That may happen again in March. But whether the seemingly indestructible Suharto, now aged 76 and very firmly a member of the older generation, is still in place at the millennium is now increasingly in question.
Not that he is likely to be forced to hand over the office, either by military pressure or an outburst of people power: Indonesia is too strongly wedded to the idea of stability and too fearful of a repeat of the brutal events of 1965 when hundreds of thousands were killed in the last handover of power. But there is no doubt that as the turn of the century looms, so does the end of an era in Indonesia.
For reasons of age alone, a transition in power is unavoidable. The big question is, can it be achieved peacefully and will the new leadership be able to handle a country which is widely regarded as one of the more difficult Asian nations to run.
There is no doubt that rumblings within the political elite and the business establishment have been growing. Concerns have focused on the need for some kind of succession plan to be put in place, which will allow Indonesia to maintain the stability that underpins its growth economy, Suharto’s greatest contribution to his country’s development.
“There are two clear risks to Indonesia’s future,” a senior economic technocrat close to the cabinet said earlier this year. “One is the possibility that Suharto could stay on and become isolated. Few dare to speak to him, he is so powerful, and he could do a lot of harm. The second is his children. So far their activities have not affected efficiency or growth but deregulation has been slowed where their interests are involved. They could eventually be a politically destabilizing factor.”
A senior executive in one of Indonesia’s largest conglomerates echoes his anxiety. “We are not so concerned about who takes the presidency,” he says. “It doesn’t have to be Suharto. The country has moved beyond the need for strong-man rule. But the children are a worry; they could cause instability by provoking political unrest.”
When Suharto’s wife of more than 50 years, Ibu Tien, died suddenly early last year, it was not long before Indonesians realized the important role she had played in the family. Within weeks of her death the couple’s business-minded children were on the rampage. Already prominent in the private sector with numerous large companies, the children’s demands grew rapidly, with Suharto’s youngest son winning approval for a national car project and his eldest son and daughter becoming players in the Busang gold mine scam. Both ventures drew unwelcome international attention.
Meanwhile, the domestic political temperature rose, sparked by the removal of popular politician Megawati Sukarnoputri from her post as chairman of the Indonesian Democratic Party (PDI). The government had moved to neutralize this daughter of Indonesia’s first president, Sukarno, seeing her as a possible focus for discontent in advance of elections due earlier this year. Its action simply speeded up the process: Jakarta saw its worst riots in years when a gang of thugs ejected Megawati supporters from the party’s headquarters in July last year.
The government’s fear that she had strong support proved correct in the June general election, when the ousted leader called on supporters to reject the PDI under its puppet leader Surjadi. The party was decimated at the polls, winning a mere 3% of the vote.
Golkar, the ruling group supported primarily by civil servants and the military, saw its vote rise to 74%, its best result in years. But allegations of fraud marred the results, with many believing that abstentions, effectively votes for Megawati, had been added to the government’s pile. A second small opposition party, the Muslim-oriented United Development Party, also rose to the challenge, attracting massive numbers of disenchanted “little men” to its rallies. These poor, but upwardly mobile, Indonesians had been too busy in former years filling their rice bowls to take an active interest in politics. When thousands joined motorbike convoys through the cities of Java protesting at corruption and collusion, it became clear that political awareness in Indonesia had reached hitherto unknown levels.
The rioting and the election campaign provided a wake-up call to a government in power for three decades. “There’s a perception of disparity between the rich and poor,” says Juwono Sudarsono, a political scientist who advises the military. “It’s a matter of urgency to fix the imbalance between the conglomerates and the less well off, to promote small and medium-sized businesses and give them access to credit. Local governments must deliver in the face of stronger political demands for openness. Control of the media and an overzealous approach to stability needs to give way to more flexibility and local autonomy.”
He believes that while the army will remain involved in domestic politics for the next 10 to 15 years, this doesn’t exclude civilians from assuming control of politics, with civilian professionals taking over from men with military backgrounds.
“The election result has made Golkar and the army feel comfortable,” he says. “The political situation has stabilized. That will allow a recognition that the conflict within the PDI should be resolved. The PDI represents several political strands within Indonesia and must be allowed to function.”
The signs are that one hurdle-blocking change has been overcome – a refusal by Suharto to move on at all. Last year a managed transition looked unlikely. “A Javanese man can’t say no to his children,” said Sudarsono at the time, adding that Suharto would not be happy to retire unless he felt he would be protected. “He has been concerned about the fate of the two former presidents now in jail in South Korea.”
Now times appear to have changed and new key players are emerging in the run-up to the presidential election. So are new scenarios about how a power transition might work. Five figures stood out during the earlier campaign, and their behaviour ever since has been closely watched. They are believed most likely to be the foremost political power brokers in the post-Suharto era. The five are:
* head of the ruling Golkar party and former minister of information, Harmoko;
* the president’s daughter, Tutut, a leading businesswoman who also plays a senior role in Golkar;
* Raden Hartono, former army chief-of-staff and now minister of information;
* Adurrahaman Wahid, leader of the largest Muslim group in Indonesia, the Nadhalatul Ulama, which commands the support of at least half the electorate, 34 million voters in the heartlands of Java;
* BJ Habibie, minister of state for science and technology, a key Suharto protégé.
All five campaigned strongly for the ruling party, with Wahid escorting Tutut to mass meetings of his followers. Many supporters were somewhat bemused at his support for Golkar, as the Muslim leader had formerly backed Megawati’s PDI. Wahid’s change of heart seems to have been sparked by his concern that political discontent could cause a growth in Islamic politics, as unhappy voters switched to the remaining opposition party, following the ousting of Megawati. Though a democrat, Wahid is strongly opposed to the involvement of religion in Indonesian politics, fearing that it could destabilize and even split the country.
Harmoko, who dominated television screens for months before the campaign actually started, saw his popularity nose-dive during the election as his media overexposure backfired. Nevertheless he brought in the votes. Shortly after the election he was removed from the powerful information ministry to a ministerial post without portfolio but with special duties relating to the parliament. He is expected to take over the constitutionally important role of speaker of the house of representatives and of the assembly which elects the president. In constitutional terms, this job rates higher than the presidency. Harmoko also remains head of Golkar.
Hartono took over from Harmoko at the information ministry, his first civilian post. And last month, Hartono was also asked to join the talking shop, the Association of Muslim Intellectuals.
The thinking behind the association has never been clear. Set up in the early 1990s at a time when Suharto was burnishing his Islamic credentials – a well publicized pilgrimage to Mecca with his family was conducted at the same time – it runs a think tank which holds seminars, and publishes a popular newspaper. For some years it was believed to be a vehicle for the political aspirations of its chairman Habibie, long regarded as a possible vice-presidential candidate and promoter of high-tech industries such as aerospace, military equipment and nuclear power.
Last month Hartono was asked to join. Meanwhile, Habibie indicated that his aspirations were in engineering and in promoting Islam, ruling himself out as a vice-presidential candidate.
As Hartono moved from the military to the political spotlight, observers suggest a political scheme is being developed along the following lines: Suharto is elected for a seventh term in 1998, with Hartono taking the vice-presidency. During his five-year term, Suharto gradually turns over the reins of power to Hartono while daughter Tutut ascends to the chairmanship of Golkar.
Eventually Suharto leaves the stage, possibly to play an informal elder statesman role behind the scenes. Hartono takes over as president while Tutut moves to the vice-presidency, acting as the eyes and ears of her father inside the palace, but leaving herself time to get on with her considerable business interests.
Would it work? Possibly. For many Indonesians, especially in the business world, any succession plan would be better than none. Hartono, aged 56, is a tough professional army man who has the basic qualifications for the presidency – he is a Javanese Muslim acceptable to all groups. Although little is known about his political views, he is clearly close to the Suharto family while also enjoying the respect of the all-important military.
His performance as an officer may make him a better candidate in the military’s eyes than another general, Try Sutrisno, the low-profile current vice-president, who earlier blotted his copybook with some intemperate statements about Indonesia’s rebellious East Timor region. Meanwhile, General Prabowo Subianto, a bright officer married to one of Suharto’s daughters, may be too young at 46 to rise to such a senior post.
In the obscure world of Indonesian presidential politics, civilian candidates such as Habibie or Ginandjar Kartasasmita, planning minister with an air force background, could still emerge. But the installation of Tutut as vice-president while her father remains leader is regarded as an impossibility.
Nor does anyone expect a senior role for Megawati Sukarnoputri in the near future. But in the long term she cannot be ignored, and her gradual return to the political arena is likely. At Indonesia’s annual independence day celebrations at the state palace in August, Megawati and her family took their places in the front row representing Indonesia’s first president, alongside Suharto, its second, and his children. As the Indonesian political story unfolds in the years to come, the battle of the daughters could well move to centre stage.
