The World Bank, the coordinator of the Consultative Group on Indonesia (CGI), has again reminded the government of the vital importance of reform for the generating of sustainably high economic growth.
This is the central theme that may be drawn from the brief the World Bank prepared for the CGI creditor consortium, which will convene its annual meeting here Wednesday to assess Indonesia's economic problems and prospects, and its external financing needs for this fiscal year.
The challenges in the reform area lie on two fronts. While the pace of reform announcements has been much slower than expected, the implementation of policy reform has been even more disappointing. The cumulative impact of these problems is a disappointingly slow recovery in public and private investment, both of which are sorely needed to provide work for the almost 12 million fully unemployed people, and the some 40 million underemployed people working in the informal sector.
Reforms in the areas of taxation, customs and excise, investment, labor regulations and public administration, including local government administration, are running far behind schedule. Consequently, we may conclude that President Susilo Bambang Yudhoyono's government, now in its second year in office, has been unable to take advantage of the momentum provided by its strong political mandate to fully restore investor confidence.
The government should be commended for the comprehensive packages of reforms in the infrastructure and investment sectors that were launched in the first quarter. However, their implementation has remained quite slow. Just look at how the second infrastructure summit has been postponed twice. It was originally scheduled for February, then was rescheduled to June but has now been again postponed until November because the implementation of many reforms in this sector has fallen behind schedule.
The adverse effects of the slow pace of reform are already reflected in less-than-expected employment growth.
The investment rate, although it has rising to 22 percent of gross domestic product, remains far below the 30 percent level achieved during the immediate pre-1997 crisis period. Yet more worrisome is the discouraging development in the relationship between overall growth and job creation. Put another way, the number of jobs created by one unit of economic growth is now much smaller than before 2000, apparently because rising unit labor costs are exceeding productivity gains, while relatively rigid labor rules have prompted new investors to eschew labor-intensive ventures.
Consequently, if this trend continues, annual economic growth of 7 percent will be required to provide work for the unemployed and new job seekers entering the labor market annually. This is rather a bleak outlook because even with good progress with the reform agenda, it has been forecast that the country will only regain a high growth scenario of 7 percent a year beginning in 2009.
It is strongly recommended, therefore, that the government show stronger leadership in speeding up the reforms, not only in the economy but also in basic infrastructure and public administration (governance), including local administration.
Inadequate budget-management capabilities on the part of regional (provincial, regency and municipal) administrations has now become the single most important fiscal concern as these administrations now account for around 55 percent of public sector capital spending. The government's failure to conduct economic pump priming in the first semester through budgetary front-loading should be blamed mainly on the utterly abysmal capacity of local administrations to properly spend their resources.
As in its previous report, the World Bank, though referring to significant progress in the anticorruption drive, cited inefficiency and rampant corruption within the public sector, notably in the taxation, customs and excise, and business licensing arenas, as some of the most serious obstacles to new investment.
Neither the government nor the House of Representatives should take the World Bank's advice as an attempt to interfere in Indonesia's internal affairs. Neither, however, does it mean that the government should push through reforms simply to obtain foreign aid.
The creditors do not expect immediate completion of all the reforms needed to restore sustainably high economic growth, given the complex challenges involved. Nonetheless, they do want to see the government lay out a clear road map for reform, maintain policy coherence and remain on the right track.
The basic reality is that the creditors will simply be wasting their money if, for example, corruption continues to undermine the effectiveness of government investment expenditure, and reforms in the economic, public-sector governance and judicial sectors are not carried through.