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Economic Reforms in Indonesia after the 1997/98 Economic Crisis Hadi Soesastro Haryo Aswicahyono Dionisius Narjoko Challenges: Weak Investment Performance • Megawati’s administration was able to restored macroeconomic stability, • But microeconomic performance was dismal. • Weak Investment Performance: Recorded foreign direct investment (FDI) continued to be negative in the first half of 2004. • Indonesia is the only crisis-affected economy in Asia in which, Investors—foreign and, more importantly, local—are still essentially holding back FDI Domestic Recession Deregulation 2003 1999 1995 1991 1987 Oil Boom 1983 1979 1975 1971 1967 Billions of $US 45 Crisis 30 15 0 Background • SBY assumed power under the backdrop of favourable environment • Institutional Setting – greater authority has shifted from the President to Parliament. – key economic ministers are less connected by shared views and constituencies. – decentralization has shifted much responsibility to the regions. • As a result, policy decision-making has become fragmented policy uncertainty First Attempt: Infrastructure Summit • Investment requirement: 5% -10% of GDP (around $140 billion) • Financing gap need private sector participation • Government held infrastructure summit, offer 91 projects ~ $22.5 billion to private sectors • Organized by Coordinating Minister for Economic Affair (Aburizal Bakrie), KADIN and BAPPENAS • Great interest from domestic and foreign investor (oversubscribed). However none of the projects were realized Why Infrastructure Summit Fail • Coordinating Minister did not have clear strategy – No strategy regarding 14 regulations necessary to provide a sound legal basis for private sector participation – Government guarantees regarding project risks – Pricing Policies – General investment climate • Coordinating Minister did not have enough authority and capacity to force the technical ministry to tackle those problems (eg, 14 regulations, pricing policies, guarantees) Second Attempt: Investment Package • Under the Coordinating Minister for Economic Affair (Boediono) • Approach: IMF Style – Substantive sectoral reforms with clear objective – Clear Time table – Clear on who is responsible for each reform • Content: general investment policies (eg licensing procedure, investment law); customs, excise and duties policies; taxation; labour; and small and medium enterprises (SMEs) Why Investment Package Fail • Also failed, why? – No clear mechanism to evaluate the progress of the reform – No clear incentives weather the reform is implemented or not – The coordinating minister does not have enough authority to force the implementing agencies (Technical ministries, DPR) to implement the reform Toward Explanation: why the reform failed • The success of reform is a result of the interplay between: – The determinants of why policy is not implemented • Regulators do not know what is ‘best-practice’. • Governments face political resistance from vested interests. or Governments do not want good policy, because they rely on the rents from bad policies • Government want a good policy but does not have enough resource, capacity and/or authority to implement the reform – Actors involved: • Within government: president, coordinating minister, technical ministers, local government. • Outside government: parliament, chamber of commerce, various interest groups. • Applying this framework: – During SBY period: • President, Coordinating ministry, chamber of commerce, and some reform-minded ministers may know the best practice, but has low authority • Technical ministries, the parliament, and other interest groups in general do not know the bestpractice, derive considerable rents from bad policies, but have strong authority.