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16 February 2000

Text: Geithner Feb. 16 Testimony to House Subcommittee on Indonesia

(Treasury official: "Indonesia still faces major challenges") (3180)
While the Indonesian government under President Wahid has taken
important steps towards economic recovery, it still faces major
challenges, according to Treasury Under Secretary Timothy Geithner.
In testimony delivered February 16 before the House Committee on
International Relations Subcommittee on Asia and the Pacific, Geithner
said Indonesia's macroeconomic environment has stabilized, and output
has begun to expand again. The new government, he noted, has adopted a
new framework for economic policy with the support of the
International Monetary Fund, World Bank, and the Asian Development
Bank.
But in the U.S. view, Indonesia still faces major challenges in the
following areas:
-- Macroeconomic dimensions of growth. "Indonesia faces a difficult
balance between the near-term need to stimulate the economy, invest in
social programs and recapitalize the banking system, and the longer
term challenge of reducing public debt and reducing dependence on
foreign official assistance," Geithner said. It is critically
important, he said, that the government preserve the independence of
the central bank, "whose policies have been responsible for much of
the return to (economic) stability."
-- Financial sector and corporate sector restructuring. An
economically strong Indonesia depends on strong private sector
activity, Geithner said. "A recovery in private investment now depends
critically on progress toward repairing the financial sector and
restructuring insolvent banks and corporations," he said, but
progress, so far, has been slow.
-- Bolstering transparency and the rule of law. "Creating a legal
system that allows creditors to enforce their rights, permits the
bankruptcy regime to work, and provides a mechanism to begin to
unravel the legacy of corruption this government inherited is
essential to recovery in Indonesia," Geithner said. "Foreign
investment and domestic flight capital are unlikely to return to
Indonesia in the amount necessary to finance future growth until
investors are more confident that they will be treated fairly by the
legal system," he said.
-- Investing in human capital. Indonesian citizens will need tangible
improvements in their welfare if they are to support economic reform,
the Under Secretary said. Improved health, education, and social
services will be needed to increase public confidence, he said.
"The United States and the international community should be prepared
to help Indonesia with its ambitious reform agenda," Geithner said. He
noted that the United States is ready to work with the Paris Club
creditors to achieve further rescheduling of Indonesia's debt in order
to give the Indonesian government two years to carry through it
economic policy agenda.
The Clinton Administration is also willing to provide an expanded
program of technical assistance, in cooperation with the State
Department, U.S. Agency for International Development and other
agencies targeted at public debt management, fiscal decentralization,
financial and corporate restructuring, and law enforcement, Geithner
said.
Following is the text:
(begin text)
TREASURY NEWS FROM THE OFFICE OF PUBLIC AFFAIRS
FOR IMMEDIATE RELEASE
February 16, 2000
LS-399
TREASURY UNDER SECRETARY TIMOTHY GEITHNER
TESTIMONY BEFORE THE HOUSE SUBCOMMITTEE ON ASIA AND THE PACIFIC
Introduction:
Thank you for giving me the opportunity today to offer the perspective
of the Treasury Department on U.S. policy toward Indonesia.
Indonesia's future is critical to the stability and prosperity of
Southeast Asia and the region as a whole. The United States has a
major stake in the success of the political transition now underway
and in seeing the foundation laid for a strong and durable economic
recovery.
I will focus my remarks on three subjects:
-- The sources of the economic recovery underway in the region and
what lessons this holds for policy makers in Indonesia.
-- A review of the major economic policy challenges facing the new
Indonesian government.
-- The broad strategy we have adopted to support recovery in
Indonesia.
Sources of Recovery in Asia
Your hearing takes place in the context of a remarkable improvement in
economic and financial prospects for emerging Asia as a whole.
-- Growth across the region has recovered more rapidly than expected,
with most economies in the region estimated to have expanded at a rate
of 4 to 9 percent in 1999.
-- With the restoration of investor confidence, currencies have
stabilized, and interest rate spreads over U.S. securities have
approached pre-crisis levels (and in some cases fallen below).
-- The process of repairing financial systems has begun, and corporate
restructuring is underway.
--Current account surpluses are adjusting to more moderate levels as
domestic demand strengthens.
These improvements came from a complex and varied mix of factors
across countries. But the dominant lesson of the financial crises of
the last several years is that countries that react rapidly with
strong, credible stabilization and reform programs are likely to fare
better than those that find it difficult to do so.
In Asia, the common elements of success were:
-- The development and implementation of a sound framework for
monetary and fiscal policies that gave investors the confidence
necessary to stabilize exchange rates.
-- Rapid implementation of a credible plan to restructure the
financial and corporate sectors so that the overhang of debt could be
lifted and private sector lending and growth could resume.
-- Early progress toward creating the right legal and regulatory
infrastructure for private investment and growth (especially a
functioning and credible legal system that protects property rights
and a working insolvency regime), and improved transparency by
regulatory agencies, corporations and financial institutions.
-- Commitment to openness to trade and foreign capital.
-- Political leadership that inspires confidence, at home and in
global financial markets, in its commitment and its capacity to get
things done.
Where these conditions were satisfied, the financial support and
advice provided by the international institutions were remarkably
effective in generating positive economic results. Where they were
not, or where a positive commitment on paper was overwhelmed by
political uncertainty or undermined by political constraints on
implementation, the crisis was much deeper and more protracted and
recovery much more difficult to establish. This is, in a sense, the
story of Indonesia since the fall of 1997.
Indonesia's Economic Challenges
Indonesia has taken some important steps to lay the foundation for
economic recovery.
The macroeconomic environment has stabilized, and output has begun to
expand again. After the deep declines of 1998 and early 1999, the
economy is expected to expand at an estimated 1.8% annual rate in
FY1999 (ends March 31), and the government expects it to grow 3 - 4%
in FY2000. Inflation has been reduced sharply to near zero, from a
high of more than 75% in late 1998. Nominal interest rates have fallen
dramatically, with the yield on one-month central bank certificates
now only 11% (down from around 65% in late 1998). Real interest rates
have also declined from their peak in mid 1999. The rupiah has
strengthened significantly from the depths of the crisis, though it is
still estimated to be about 25% below the pre-crisis level in real
trade-weighted terms.
The new government has adopted a new framework for economic policy,
with the support of the IMF, World Bank and Asian Development Bank,
which holds the prospect of maintaining macroeconomic stability and
creating greater confidence among domestic and foreign investors. On
February 4, the IMF Board of Directors, with U.S. support, approved a
new three-year program for Indonesia. Now, Indonesia must focus on
implementation of its policy agenda.
In our view, Indonesia faces four main economic challenges.
1. The Macroeconomic Dimensions of Growth
Indonesia can take considerable comfort in the progress achieved in
stabilizing inflation, the recovery in the exchange rate, and the fall
in interest rates.
Going forward, Indonesia faces a difficult balance between the
near-term need to stimulate the economy, invest in social programs and
recapitalize the banking system, and the longer term challenge of
reducing public debt and reducing dependence on foreign official
assistance.
In the economic program outlined in the agreement with the IMF, the
government decided to avoid a further expansion in the fiscal deficit
(targeted in the program at nearly five- percent of GDP for FY2000).
With ambitious targets for government asset sales and privatization of
state-owned enterprises, the government hopes to begin to reduce the
large public debt burden.
Over the medium term, once the recovery is more firmly established,
the government will have to put in place a credible program for
reducing the public debt burden further, and as it moves toward fiscal
decentralization, will have to ensure that the transfer of fiscal
resources to the regions is accompanied by a commensurate transfer of
responsibilities and capacity.
In this context, it is critically important that the government commit
to preserve the independence of the central bank, whose policies have
been responsible for much of the return to stability.
The government's macroeconomic framework is designed so that, by the
end of the IMF program, Indonesia would no longer need exceptional
balance of payments support or further debt rescheduling.
2. Financial Sector and Corporate Sector Restructuring
Economic growth will not recover with any strength in Indonesia
without a recovery in private sector activity. A recovery in private
investment now depends critically on progress toward repairing the
financial sector and restructuring insolvent banks and corporations.
The Indonesian government's efforts to restructure, recapitalize, and
privatize both the state-owned and nationalized banks (which together
now account for about 70% of banking system liabilities) have been
painfully slow and inadequate. The Indonesian Bank Restructuring
Agency (IBRA), which now holds assets amounting to roughly 50% of GDP,
has made alarmingly little progress in recovering non-performing loans
and disposing of the assets that it now holds. Restructuring has been
hampered by private debtors' belief that they ultimately will not be
forced to pay, foreign banks' reluctance to invest due to concerns
about transparency and governance, and political pressure on IBRA not
to write down or collect on claims. Restructuring delays have severely
impeded the growth of bank credit and added to the government's fiscal
costs and already high debt burden.
Financial and corporate sector restructuring is the central focus of
the government's program with the IMF. The program outlines several
priorities for the financial sector: first, restructuring and
privatization of state-controlled banks, which the Indonesian
government committed to begin before the end of March; second,
improving supervision and governance in the banking sector; third,
minimizing the public cost of the remaining recapitalization; and
fourth, deepening bond and equity markets, which will provide
alternatives to bank finance.
On the corporate debt restructuring side, the IMF program calls for:
stronger powers for IBRA, able to restructure debt without political
interference, and mandated to send recalcitrant debtors to bankruptcy
court; better implementation of the bankruptcy law, so that the threat
of bankruptcy proceedings provides troubled debtors with a real
incentive to restructure debt with creditors; and measures to combat
corruption in the judiciary, including stepped-up investigation of
bankruptcy judges suspected of corruption.
3. Bolstering Transparency and the Rule of Law
The challenge of creating a legal system that allows creditors to
enforce their rights, permits the bankruptcy regime to work, and
provides a mechanism to begin to unravel the legacy of corruption this
government inherited is essential to recovery in Indonesia.
This is why the work of the newly appointed Indonesian Attorney
General is so important to the success of the economic program. This
is why the U.S. and other countries, working with the international
financial institutions, made judicial reform a centerpiece of the
recent consultative group meeting of donors.
Foreign investment and domestic flight capital are unlikely to return
to Indonesia in the amount necessary to finance future growth until
investors are more confident that they will be treated fairly by the
legal system, that they will be protected from discrimination, and
that they will be safe from the selective assignment of privileged
economic rights that prevailed under the Suharto regime. This
confidence is critical to an effective process of unwinding the
complex interests tied up in the claims now held by the government.
The IMF program outlines measures for greater transparency in many
areas, including fiscal management (both in central and regional
governments), the operations of the central bank, the judicial system,
and commercial bank and corporate governance (including accountability
and disclosure standards).
The IMF LOI includes a strong commitment to audit the Indonesian
military, including extra-budgetary sources of income, and to report
findings to civilian authorities. The Indonesian Coordinating Minister
for Economics and Industry, Kwik Kian Gie, has assured us that the
audit has begun and will be completed by August 31.
The LOI also contains commitments to speed up the resolution of
disputes with independent power producers (IPPs). The new government
has committed to become directly involved in accelerating negotiations
between the state power company and the IPPs and has already taken the
step of replacing the state power company's management, and ensuring
that various lawsuits against several IPPs were dropped.
The new government has moved to address one of the most conspicuous
recent examples of public corruption in the Bank Bali case. An
independent investigation of the scandal by was undertaken by
PriceWaterhouseCoopers (PWC) and released publicly by the Indonesian
government in October. The Indonesian attorney general took up the
investigation where PWC left off and has committed to follow through
on the investigation. The attorney general has named several suspects,
including a former cabinet minister.
4. Investing in Human Capital
Delivering a more substantial and broad-based improvement in the
economic welfare of Indonesians is a fourth important challenge for
the new government. A broad majority of Indonesians will not support
the economic reform program unless they believe that it will bring
about a tangible improvement in their welfare. In an increasingly
constrained budgetary environment, given the costs of resuscitating
the banking sector, it will be vital to ensure that social investments
are better targeted to the people who need them most. This means:
-- Building on past successes in community-based provision of basic
social services, with greater decentralization and transparency and
wider participation to command credibility and popular trust.
-- Maintaining and extending the impressive efforts that have been
made to keep children in school through the crisis -- an investment
that will pay off many times over in faster growth and greater social
cohesion in the years to come.
-- Focussing on greater and more effective provision of critical
health services -- particularly basic preventive care.
In the area of labor conditions, Indonesia has made considerable
progress during the past year in affording its workers rights of
association and collective bargaining. Partly in response to the
urging of the United States and the IMF, Indonesia ratified ILO
Convention 87 (Freedom of Association) in 1998. During 1999 Indonesia
ratified ILO Conventions 105 (abolition of forced labor), 111
(employment discrimination), and 138 (child labor), becoming the first
East Asian country to ratify all seven of the core ILO conventions. We
have been informed that Indonesia intends to introduce new labor
legislation by October of this year, which would bring its laws into
conformance with the ILO conventions.
An Agenda for Immediate Action
Our hope is that the new Indonesian government will move quickly to
take advantage of its electoral mandate, and the broad political
support in favor of economic reform, to move quickly to implement the
new program. Among the most important steps the new government could
take to establish its credibility with its citizens and with investors
are:
-- Demonstrating that officials of IBRA, Bank Indonesia, and other
economic agencies can carry out their official duties without fear of
inordinate political interference or constraints.
-- Indicating the government intends to get out of the banking
business, by transferring controlling shares of government-owned banks
to the private sector. An important step will be IBRA's sale of shares
in Bank Central Asia (BCA), which is expected before end-March.
-- Replacing management responsible for the large losses of
state-owned banks.
-- Demonstrating progress on disposal of assets by IBRA, even where
this means writing down debt. An important indicator will be the
planned sale of IBRA's stake in the leading Indonesian vehicle maker
Astra International. This would be a significant step toward meeting
IBRA's key end-March asset sales target.
-- Sending a clear signal to large debtors that unless they cooperate,
they will be prosecuted and their assets seized. Specifically, IBRA
needs to pursue high-profile recalcitrant debtors through the
insolvency system.
-- Demonstrating a willingness to see foreign investors as part of the
solution to Indonesia's corporate and financial sector debt problems
-- and not part of the problem -- through the sale of a substantial
stake in a large Indonesian corporation or bank to foreign investors.
As is has been true elsewhere in Asia, foreign banks could be an
important source of support for financial sector modernization in
Indonesia, not only as sources of needed capital but greater financial
resilience in the future.
-- Investigating and prosecuting judges who have engaged in corrupt
practices. The word must go out that in a new Indonesia, no one is
above the law and the laws will be fairly enforced.
Conclusion
The United States and the international community should be prepared
to help Indonesia with its ambitious reform agenda. On the economic
and financial front, we can be most effective in the following areas:
-- Supporting an adequate scale of official finance in this period of
economic distress and transition. The new IMF supported program
approved earlier this month will provide approximately $5 billion in
financing -- dependent on continued and forceful implementation of
conditions -- over the next three years. The World Bank and Asian
Development Bank together have about $7.8 billion in already-approved
loans in the pipeline that have yet to be disbursed.
-- Focusing the international financial institutions on the core
challenges facing the new government, with reforms concentrated on
those steps necessary to restore an environment conducive to private
enterprise and new investment, an adequate safety net with important
investments in health and education, and growth oriented macroeconomic
policies.
-- Supporting an appropriate breathing space on external debt service,
including a rescheduling of Paris Club obligations. We have signaled
that we are ready to work with other Paris Club creditors to achieve a
further rescheduling of Indonesia's obligations. This would provide
another two years of relief to strengthen the government's capacity to
carry through with its economic policy agenda.
-- Providing an expanded program of technical assistance, in
cooperation with State, AID and other agencies, targeted toward public
debt management, fiscal decentralization, financial and corporate
restructuring, and law enforcement.
Indonesia's most pressing economic challenges are in many ways more
political than economic. Progress depends critically on the political
capacity of the government to act.
The new government has outlined a credible program of political change
and economic reform. Combined with the general improvement in the
economic environment in Asia and the world economy as a whole, this
creates the potential for substantial and enduring improvement in
economic conditions for the people of this important nation.
(end text)
(Distributed by the Office of International Information Programs, U.S.
Department of State. Web site: usinfo.state.gov)