Survey of recent developments

Two major factors, one internal and one external, shaped developments through the middle of 2004. The internal factor was the national election process, which led to a realignment of political power among the parties in the legislative elections in April, and offered the prospect of even greater changes in the presidential election to follow. The external factor was foreign capital, which readily flowed into Indonesia in the early months of 2004, reflected in a series of record highs in the Jakarta Stock Exchange index, but then seemed to waver in May, perhaps because of the growing threat of higher US interest rates, uncertainty about the election, or concern about inflation. Sharp declines in the value of the rupiah and local stocks mirrored similar though less severe developments throughout Southeast Asia and around the globe. The imminent first-ever election of an Indonesian president through a direct vote by the public raised hopes of change for the better, particularly with respect to governance and the performance of the economy. However, the structural factors that have held back economic growth in Indonesia since the crisis of 1997-98 will not change overnight. The new president could have a popular mandate, but will have to assemble a coalition in a parliament in which power will be more fragmented than ever. As the presidential election approached, polls showed the electorate's top priorities to be an improved economy and reduced corruption. However, recent months have witnessed several steps backward, as interventions in domestic trade and the escalation of fuel subsidies have created costly inefficiencies and new opportunities for corruption. A recent proposal to establish a vast new social security system monopolised by the government is also problematic in an environment in which governance remains weak. Personal income tax changes being considered by the Ministry of Finance could significantly reduce government revenues, an outcome the government can ill afford. Despite enactment of a host of new laws in the last six years in such areas as anti-monopoly, bankruptcy and anti-corruption, as well as the initiation of a long-term judicial reform process, recent events have shown that the legal system remains a major source of uncertainty in the business environment.