Dean Yates, Jakarta – The World Bank said on Monday it expected Indonesia to "muddle through" its economic woes, adding the most urgent tasks were to ensure fiscal sustainability and improve the climate for private investment.

In a report prepared ahead of an annual donors meeting this week, the bank said progress on Jakarta's latest pact with the International Monetary Fund, signed in late August and which the bank called feasible and realistic, had been disappointing.

It said President Megawati Sukarnoputri's government had made little movement on structural and governance reforms, renewing financial market nervousness and worrying creditors.

The bank repeated a forecast made last month that Indonesia's economy would grow 3.3 percent this year and 3.5 percent in 2002, slightly lower than the government's budget forecasts. Jakarta expects growth this year of 3.5 percent and four percent in 2002.

"The bank places Indonesia squarely in the 'muddle-through' scenario ... In this scenario, Indonesia maintains a modicum of macroeconomic stability, but implements structural reforms in fits and starts, with some policy reversals," the report said. "... In the absence of decisive policy action, the fiscal position remains marginally sustainable. But donors need to be realistic about what is feasible, given strong vested interests, severe institutional weaknesses, the uncertainties arising from decentralisation and a turbulent transition to democracy," the report added.

The World Bank first raised the "muddle through" scenario in February at a time of rising political instability, with MPs seeking to bring down former President Abdurrahman Wahid over his erratic rule. Those efforts succeeded in late July, and political tension has largely subsided since Megawati took over.

Indonesians remain vulnerable

While the growth forecasts appeared robust compared with other Asian countries, the bank said they were too low for Indonesia because recovery had lagged behind its neighbours and more than half its 210 million people were vulnerable to poverty.

The bank said Jakarta's most immediate priority was to ensure fiscal sustainability for stability and as a foundation for growth. The 2001 fiscal outlook was worrying with a shortfall seen in domestic and foreign financing of the deficit, it said. Jakarta has forecast a budget deficit of 3.7 percent of gross domestic product for this year, shrinking to 2.5 percent in 2002.

"Moreover, Indonesia's fragile banking and corporate sectors, and the precarious state of the government's finances, make the country highly vulnerable to risks – with immediate implications for fiscal sustainability," said the report.

It added creditors were becoming wary of lending to Indonesia when the track record gave little cause for comfort. In the past four years, of all pledges made by donors under the Consultative Group on Indonesia (CGI), $9 billion had not been disbursed.

Image problem

Donors grouped under the CGI hold an annual meeting in Jakarta for two days from Wednesday to pledge fresh aid. The World Bank has said Indonesia would seek $3-4 billion. The report added Indonesia needed a big boost from private investment to stimulate growth because exports would suffer in the global economic slowdown while Jakarta's debt morass ruled out using the budget.

But it said Indonesia's image had been hurt by the handling of some legal disputes and over the difficulty in selling stakes in key state assets such as cement maker PT Semen Gresik and Bank Central Asia BCA. "In all these cases, there is a clear perception that actions by the authorities reflect a systematic bias against foreign investors and an unequal application of the law in favour of domestic debtors," said the report.

That image took another bashing with last week's unilateral takeover by West Sumatra province of a key unit of Gresik to stop it being acquired by Mexican cement giant Cemex. Rooting out graft would be a long fight, the report added.

"The critically weak and almost dysfunctional condition of the justice sector in Indonesia – the judiciarybGeneral's office, the police – is one of the most fundamental impediments to both economic recovery and sustainable long-term development of the country," said the report.

It said hefty government debt was a potential cause of economic instability because of the burden on the budget. Total state debt stands at some 100 percent of GDP, or $140 billion.

The report added that regional autonomy laws which devolve more power to local authorities and that were implemented in January had begun better than most observers, including the bank, had expected.