Michael Schuman – A deteriorating Indonesian economy could constrain new President Megawati Sukarnoputri's efforts to pursue much-needed reforms.

Growth in Indonesia's gross domestic product slowed to 0.18% in the second quarter, compared with a 1.8% expansion in the preceding quarter. Year-to-year, the economy grew 3.5% in the second quarter, compared with 4.1% in the same period in 2000, according to government figures released Wednesday.

The slowdown is the result, in part, of weaker exports and weaker domestic consumption, which grew 3.3% and 0.16%, respectively, from the previous quarter, compared with growth of 8.3% and 2.2% in the first quarter. Some economists expect the downward trend to continue. "The second half will be worse," predicted Arjuna Mahendran, an economist at SG Securities in Singapore. He forecast 2001 growth will be 2.9%, compared with 4.8% in 2000. Earlier this year, Jakarta projected 2001 growth of about 3.5%.

Indonesia's senior economics minister, Dorodjatun Kuntjoro-Jakti, said in an interview last week that Indonesia needs to see annual growth of 7% to begin creating enough jobs to absorb millions of unemployed workers. He conceded that he was skeptical that such high growth could be achieved in the near future with industrial economies sagging. "We still depend on the US," Mr. Dorodjatun said.

Last week's appointment of Mr. Dorodjatun and a team of economic technocrats to Ms. Megawati's first cabinet has raised hopes that better policies could give the economy a lift and help end a political crisis that gridlocked decision-making under former President Abdurrahman Wahid. Mr. Wahid was ousted in late July by Indonesia's highest legislative body and succeeded by Ms. Megawati.

The resulting improvement in business sentiment has pushed the rupiah up 27% against the dollar since Ms. Megawati assumed the presidency. But export growth could be damaged if the rupiah continues to strengthen, making local goods more expensive in foreign-currency terms, some economists said. Indonesia exports mainly commodities and cheap manufactured goods, and although it hasn't been hit as hard by the US slowdown as producers of higher-end electronics, such as Singapore and Taiwan, the country is still suffering from weak global demand.

Ms. Megawati needs to use the early support she's received for her economic team to push ahead with reforms, analysts said. Mr. Dorodjatun stressed the need to revive the country's feeble banking system so it can better support manufacturing companies and spur fresh investment. He also wants to fortify the state budget, strained by interest payments on the public sector's $68 billion in debt. Such steps will likely be more difficult to achieve if the economy continues to slow, dragging down state revenues with it.

To get the economy moving again, Ms. Megawati also will need to take on entrenched political and business interests. But she has given mixed signals about her willingness to do so. On Monday, Ms. Megawati gave former Citibank banker Laksamana Sukardi oversight of the country's debt-restructuring agency. Mr. Sukardi is expected to speed asset sales and possibly crack down on corporate debtors who have dragged their feet on restructuring plans.

But late Tuesday, Ms. Megawati appointed a relatively unknown state prosecutor, Muhamad Abdurrachman, as her attorney general. The appointment didn't inspire confidence that the new government will try to stamp out the corruption that plagues Indonesia's economy. "I don't think he is going to be aggressive," said human-rights attorney Frans Winarta of the new attorney general. "If you want to make a breakthrough, then you must have an outsider." Separately, the White House announced that President Bush will host Ms.

Megawati for a visit in Washington Sept. 19 to discuss political and economic reforms in Indonesia. The announcement follows a visit to Jakarta last week by US Trade Representative Robert Zoellick.

[I Made Santana of Dow Jones Newswires contributed to this article.]