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THE JAKARTA POST
OPINION
MONDAY, JUNE 24, 1991
PAGE 7

Trend of economic growth in the 1990s encouraging thanks to deregulations

[[italicized]] The following is the first of a two-part article based on the speech by [[bold]] Iwan J. Azis, [[/bold]] senior economic lecturer at the University of Indonesia, at a Tourism Workshop held by the ASEAN Tourism Association in Jakarta on June 19. [[/italicized]]

By Iwan J. Azis

JAKARTA: During the early period of deregulation (1986-1988) Indonesian economic growth was relatively steady at over five percent annually. The Peak was in 1989 when most reforms began to produce some real effects and at the same time the total terms-of-trade was slightly improved. Despite some adverse impacts of the world's economic slowdown upon the non-oil exports on the one hand and the increasing pressures of domestic inflation on the other, the economy remained strong in 1990 with an estimated growth rate of 7.1 percent. 

The agricultural sector performed relatively well in 1989 (4.3 percent). Its largest component, the food sector, increased relatively strongly (around 3.6 percent) while the export-oriented plantation grew more than five percent. In 1990, however, the sector's growth is slacking (3.5 percent) due to the unfavorable weather condition and deteriorating terms of trade. Meanwhile, the total mining sector increased by 5.2 percent in 1989. The steady growth of oil & gas component of the sector results in a relatively similar rate for 1990 (five percent). 

In the last five years or so the manufacturing industry has been performing the best under the deregulation scheme. The average annual growth rate of the non-oil industry in 1986-1989 was around 11 percent. An annual growth figure higher than 10 percent was recorded for 1990, in which the export-oriented sectors continued to perform well. The non-oil component of the manufacturing sector produced a double-digit growth rate (11 percent) in 1990. 

[[bold]] Growth rate [[/bold]] 

Following the above trend in the goods sector, construction activities have increased accordingly fast. The growth rate of the sector accelerated from 9.5 percent in 1988 to around 11 percent in 1989 and 13 percent in 1990. In fact, the strong demand for construction materials, such as cement, have surged significantly indicating the heated economy. Based on the assumption that part of the problems causing the excess demand lies among others in the transportation of such important construction materials, imports of commercial cars have been recently allowed. Another important decision was to allow direct imports of the cement with zero import tax. Meanwhile, the longer-run solution is seen through the construction of new cement factories and efforts to optimize the operation of existing ones. The transport and communications sector performs a relatively strong growth in 1990 (7.1 percent), although not at the 1989 speed (almost nine percent). 

[[bold]] Banking [[/bold]]

Within the services sector the fastest growing sub-sector has been in banking and other financial activities. After the banking deregulation in 1983, the annual growth rate of this sub-sector was around nine percent (from 1983 to 1988). Following another major financial deregulation in October 1988 (known as "Pakto") the sector's value-added further jumped by 14.3 percent in 1989. 

The number of banks and other financial institutions increased dramatically in 1989 and 1990, although some disruptions were also observed, particularly during 1990. There seems to be an overwhelming contention that the central bank's supervisory role is in great demand following active deregulation in the financial sector. Furthermore, there have been fears that the boom in the industry could hit some snags because of cutthroat competition on the one hand and a lack of supervision by the central bank on the other. 

For now there seems to be divided market, one for the upper and big banks and another for groups of middle and small banks. The latter, as expected, are in a more difficult position since the dominating state banks tend to favor lending to the powerful (big) private banks. The situation is even more complex given the fact that a tight money policy is currently in effect. 

Another important sub-sector within the services sector is trade. As a separate sector the trade generated value added (GVA) is the fourth largest (13.3 percent) after the agricultural sector (20 percent), mining (20 percent) and manufacturing (14.2 percent). The sector's GVA is closely related to the real flows of imports and exports. In 1989 this sub-sector grew by 10.5 percent, which was almost double than the average annual growth rate during 1983-1988. 

In 1990 the trend remained strong although the efficiency of the sector had been adversely affected by the imposition of a relatively high fee initiated by private parties responsible for the distribution of some products (e.g. petrochemical products). 

Despite the slow down in the growth of non-oil exports, the GDP retained a 7.1 percent growth in 1990. While throughout 1987 exports contributed most to the GDP increment, in 1990 the growth came mostly from investments and consumption expenditures. In real terms the government investment is expected to surge by nine percent, and the rate for private investments is almost 20 percent. Magnitude wise, hald of the total GDP growth is in fact generated via the surge of private investments. The improved investment climate appears to have contributed to such a trend. 

In the last four years export-oriented investments have been quite strong, in particular due to the interplay of push and pull factors. The push factor was promulgated by the currency alignment in Japan and NIEs which gave rise to industrial relocation, while the pull factor came from a series of deregulation packages aimed at the removal of unnecessary obstacles and structural rigidities in the economy. 

Although the figure for 1990 is not final yet, it is recorded that throughout January-October total application for direct foreign investments amounted to US$7.6 billion, which is already 60 percent of the total realized figure in 1989. However, primarily due to the Gulf crisis the realized investments may well be below this figure. Most of these investments are from Japan and NIEs. 

A similar strong trend is also observed for domestic private investments. Despite increasing uncertainties following the Iraq invasion in August last year and relatively effective tight money policy, for the whole 1990 the domestic and foreign private investments surged at much higher rates than the preceding year. 

[[bold]] Non-oil tax [[/bold]]

Since the promulgation of the tax reform in 1984 the growth of non-oil tax has been consistently strong. While the rate is almost a flat 15 percent annually during 1985/86-1987/88, it accelerated to 30 percent in 1987/88-1989/90. The fastest growth in the lat three years were revenues from the building and land tax (PBB), income tax and value-added tax (VAT). The number of taxpayers has increased significantly; twice for VAT and around 2.4 times in the case of income tax. The number of returned tax forms (under the self assessment approach) also gets larger although, in the case of VAT, it remains below 50 percent. The elasticity of the non-oil tax slightly increased from 2.16 during 1983/84-1986/87 to 2.27 in the period of 1986/87-1989/90 (measured against the non-oil GDP).

The success story seems related to the introduction of the VAT, which is a new item replacing the outdated sales tax. This is basically the centerpiece of the reform. Contrary to early expectations, the flat and uniform rate (10 percent) of VAT, including those applied on petroleum products and on imports, proved to perform satisfactorily as the "money machine" of the budget. In 1989/90 along with PBB the VAT performed the largest growth rate among all non-oil taxes, i.e. more than 33 percent (compared to 29.5 percent increase of the total non-oil tax).

[[bold]] Inflation [[/bold]]

Among routine expenditures the largest growth occurred in the wages and salary component following a raise in government employee's salary in 1989 (after a three-year salary freeze). But the largest component in the total routine expenditure remains the foreign debt and interest payments (slightly less than half in 1989/90 and a little less in 1990/1991 and 1991/1992 budgets). The realignment of some major currencies, particularly the Japanese Yen, affects significantly the Rupiah amount of this payment.

Perhaps one of the most important debates in the Indonesian economy recently is around ways to curb inflation, particularly in connection with the high interest rate and the prevailing tight money policy (TMP). It is not only the maintenance of purchasing power of the fixing income group that the government is concerned with, but it is also the fear of uncompetitive exchange rate that may give rise to slackened growth of non-oil exports. In particular, the concerns over balance of payment position and the debt payment, seem to remain strong.

The source of concern primarily stems from two forces. First is the overshooting government's liquidity credits combined with the short-term effects of banking and financial deregulation (1983 and 1988) leading to a fast growing money supply. The second force is the spiraling effect of sharp increase of fuel prices in mid-1990. Actually, there is another important source of domestic inflation often neglected in the analysis, that is, the transmission of foreign inflation. This factor may work in a hidden way for its impact is less direct and consequently difficult to track.

A proxy intermediate variable would perhaps be the price index of import goods. Judging from the trend (in 1988 the import price index increased 3.8 percent and in 1989 8.5 percent) it would be not too farfetched to assume that in the last two years the import price has been indeed increasing.

Since 1987 the inflation rates have actually declined and been successfully maintained at a single-digit level. But given the aforementioned forces the government has a well-grounded fear for the 2-digit rate in 1990 and some years to come.

[[bold]] Discrepancies [[/bold]]

The affects of financial deregulation are basically formed through unexpected discrepancies between fund mobilization and allocation. From the mobilization side the deregulation seems to work quite effectively.

However, in an environment of high interest rates it was rather difficult for the banking sector to allocate credits for proper investments with the exception those that were conducted in a less transparent manner.

On the other hand, the pressure for accumulating higher yields in order to meet the bank's obligation maunted through the end of 1990.

Unfortunately, the short-out solution results in a dramatic increase of unproductive consumption credits (e.g for automobiles, residential houses, household appliances and other consumption durable goods) through the offerings of various attractive packages. This phenomenon has inevitably placed on the economy. However, following the persistent TMP the average inflation for 1990 reached a 1-digit level, i.e around 9.4 percent.

The concern of slowing growth in non-oil exports is also mounting. The fear of overvalued exchange rate has therefore further justified the implementation of tight monetary policy (TMP).

But another prominent variable capable of affecting the economic growth is investment. As described earlier, the primary source of 1990-growth mostly came from private investments along with consumption expenditures. If the TMP persists, the rate of investments may be adversely affected and those mostly hurt would most likely be medium and small investors.

[[image]]
The workers in a shoe workshop in a village in Bandung, West Java, have to boost production to meet the big demand following deregulation measures which are meant to increase non-oil exports.

[[bold]] Slow growth [[/bold]]

Given the political repercussions, in particular taking into account the upcoming general election, it is expected that the TMP will be slightly relaxed in the near future. Even if that is the case, as demonstrated in the forecast (see later section) double-digit inflation will be unlikely since the possibility to raise the price level of some of the government controlled goods would be rather remote considering the upcoming election.

markably strong performance of non-oil and gas exports during 1987-1989, the country was forced to experience a slower growth of such exports in 1990. The average growth rate of non-oil exports for 1986-1989 was recorded more than 27 percent annually, whereas in 1990 a single-digit growth (less than nine percent) occurred, be suggesting the target set by Repelita V (15.5 percent) will likely be untenable.

It is rather interesting to observe that the declining growth in non-oil exports takes place in the face of a steady stream of deregulatioon and economic reforms aimed at inducing greater efficiency in the non-oil sector.

The government's strong commitment to increase reliance upon non-oil exports also persists. Certainly there has been no sign whatsoever of weakening the government's commitment on this policy direction despite some fears that the recent surge in oil price may lessen the urgency of further deregulation.

An immediate repercussion of the reform is evident from the factor intensity of non-oil exports in which the fastest growing exports in the last few years have been those under the category of "unskilled labor intensive" (ULI).

A deregulation package in the trade sector was promulgated in may 1990. More than 100 commodities were added to the list of items with free import duties and many more enjoy tariff reduction.

Furthermore, the May-1990 package also removed more non-tariff  barriers and further simplified the import trading system so that the ease of flows of import required for investments in the export-oriented sector would be enhanced. Another package with even more intensity in promoting further investments, trade and finance was announced in early June this year.

Hence, it would not be too difficult to suspect that demand factors may explain the declining growth of non-oil exports. Indeed, the unfavorable trends of commodity prices had inflicted primary exports from 20.4 percent annual growth during 1986-1989 to negative growth (-1.8 percent) in 1990. Even the growth of manufactured exports will likely to slow down during the same period.

However, supply constraints are increasingly binding as well. The infrastructure condition in particular has been inflicting more and more. It is predicted that without serious efforts to overcome the bottleneck the desirable impact of deregulation wil be easily neutralized

Transcription Notes:
- i stopped writing in the middle of the fifth column. continue at the title Inflation :)