David Roche – Back in the heady days of the early 1990s, Southeast Asia was in the middle of an economic miracle. Meetings between Asian and European trade ministers were occasions for Asian ministers to explain to their counterparts how Asia did it. Foreign investors were falling over themselves to lend money to Asian banks or invest in or set up Asian companies.
But now it's all changed. The confidence has gone. And now, as fast as Southeast Asia generates export earnings, money flows straight back out. So far, with the exception of Malaysia (which resorted to capital controls), more than two-thirds of the region's entire post-Asian financial crisis current-account surpluses have been invested in financial assets in the United States.
Indonesia, in particular, is at a crisis point. It needs foreign aid to balance its budget and external accounts for 2001. Its international donors, meeting in Tokyo this week, will probably continue to throw money at the administration of President Abdurrahman Wahid.
But don't confuse such charity with restructuring. The budget figures exclude any substantial clean-up of corporate balance sheets that would arise from writing down and auctioning off the assets of bankrupt banks now in the hands of the government's Indonesian Bank Restructuring Agency.
If that were to happen, the ratio of public debt to gross domestic product would jump by about 50 percentage points and interest expenses would lift the budget deficit by another four percentage points of GDP to between 8% and 9%. That's why it won't happen and why Indonesia will continue to struggle.
True, the economy appears to be enjoying a bounce back after the crisis. Right now, it is growing at about 6% and is likely to achieve 4% growth for the year. That sounds good. But it is, alas, both inadequate and unsustainable. It's driven mainly by oil and animal spirits.
Indonesia, therefore, cannot risk standing still. With more than 200 million people, it needs to grow at 8% per year just to absorb the 30% to 40% of the workforce that is currently underemployed or unemployed, in addition to a massive 3% annual growth in available workers. Most of these people are young. They overthrew Suharto's dictatorship to get a better life. If they get a worse one, the result will be an explosion of social turmoil.
The domestic economy (outside oil) remains on its back. Before the Asian crisis, in 1997, investment was $17 billion. In 1999, the figure was $9 billion. This year it's up about 16% – but it's only the percentage that's big and far short of Indonesia's needs.
Before the emerging market crash, Indonesia had a domestic savings rate of 28% of national income and foreign investment of 4% of GDP. So 32% of GDP in savings was available for investment, which generated a growth rate of 8%. That's $4 of investment for every $1 of growth.
Now the domestic savings rate in Indonesia has fallen to 17% of GDP, reflecting the country's plunge into poverty. Poverty jacks up essential consumption as a proportion of total income. And, of course, there is no foreign investment. Therefore Indonesia can invest only 17% of GDP a year today compared with 28% a few years ago. To be super-optimistic, assume the end of the Suharto kleptocracy has raised the productivity of new investment so that only $3 of investment is necessary for every $1 of growth. The maximum growth rate achievable then would still be less than 6%.
Moreover, capital productivity is unlikely to increase in post-crisis Indonesia. With the equity market turning over just $25 million a day, the only way to allocate capital is through the banks. And they are bust as bust can be and likely to stay that way.
Sure, the government has bought out the banks' bad debts and guaranteed depositors their money. But that cost more than 70% of GDP and will cost another 10% before the job is finished.
The rub is that the bad debts were bought by the government at face value and paid for with bonds. That means that the same bad loans still sit unserviced and unwritten down in the balance sheets of the entire Indonesian corporate sector. Writing down the bad debts would wipe out the entire equity of the Indonesian corporate sector, opening the way for clean new ownership with large foreign stakes.
But Indonesian politics could not survive in such a hygienic house. As long as the balance sheets of the corporate sector remain uncleansed, no one is going to invest or lend. The result is that Indonesia will be starved of investment and burdened with a totally dysfunctional banking system.
The Wahid government could push corporate debt restructuring by empowering IBRA to behave like South Korea's Asset Management Corp. through write-offs and a change of corporate management and ownership. But that is unlikely. Writing off the corporate loans would destroy IBRA's stock of lousy bank assets. IBRA losses would have to be covered by the government issuing more bonds. Writing down the value of the bonds IBRA used to buy the banks' bad debts would spread the burden of restructuring to their shareholders.
But they would likely see the value of their equity reduced to zero. The banks would then have to be nationalized, recapitalized and sold off or closed. Indonesia's corporate sector would have clean balance sheets and capital would start to flow again.
Whatever way is chosen, the result will be to push government debt up to about 130% of GDP, which will cost nearly half of the government budget to service. That's one reason why restructuring won't happen.
The other reason is political. At the core of Indonesia's policy paralysis lie incompetence and corruption. President Wahid is incapable of leading his country out of its appalling fix. His plans to devolve power and money to outlying provinces are more than likely to drain central government coffers of the resources they need to restructure the economy.
The Indonesian parliament and military continue to conspire to find a better leader. Mr. Wahid's betrayal of Vice President Megawati Sukarnoputri on cabinet posts has pushed her to give her party, the Indonesian Democratic Party, or PDI, permission to find a way to impeach Mr. Wahid. The process will take about nine months. During that time, the presidency will be paralyzed – especially since Mr. Wahid now has the support of less than 20% of parliament.
It all sounds like the prelude to the sound of tank tracks in the streets. But that is unlikely, too. The military is divided about what to do; they are disgraced in the eyes of the public. And the army is far too small to control a nation of Indonesia's size in revolt. We may eventually see a strong "leadership" scenario develop. But right now all the leaders-in-waiting look little better than Mr. Wahid himself.
Of course, Indonesia's problems are its own. But all of Southeast Asia's Mango Republics share some or all of Indonesia's symptoms. And contagion is what counts when it comes to attracting capital from busy foreign investors. That's bad news for Southeast Asia.
[David Roche is a global strategist at Independent Strategy in London.]