Megawati's Tightrope

Rising unrest threatens the economy

Indonesia may have a reputation these days as a debt-ridden, terrorist-infested basket case, but not all the news from Jakarta is bad. As a matter of fact, the government of President Megawati Sukarnoputri has been doing a laudable job of holding the economy together. Inflation, interest rates, and the outflow of capital are all down sharply over the past year. Economic growth was a respectable 4% in 2002, while foreign reserves and the value of the Indonesian rupiah rose sharply.

Credit goes to the government's tight fiscal discipline and sales of government stakes in banks and telecom companies. If reforms stay on track, the International Monetary Fund could wrap up its tortured five-year bailout program by yearend. "Based on the progress made last year, that's certainly feasible and worth shooting for," says Daniel A. Citrin, an IMF adviser working with Indonesia.

If only the tumultuous political scene would remain calm long enough for Megawati to stay the course. In January, riots broke out protesting her plan to drop a 25% subsidy on gasoline that costs the government $100 million a month and violates IMF commitments. Meanwhile, members of Megawati's ruling coalition, including Legislature Speaker Amien Rais, are attacking the government for privatizing long-distance phone company Indosat. With legislative and presidential elections expected in mid-2004, bolder opposition within Megawati's coalition government could force her to shelve new reforms.

Megawati's support for the U.S.-led war on terrorism, heightened since the October bombing in Bali that killed 200 people, also makes her politically vulnerable. Although her government opposes a U.S. attack on Muslim Iraq, she is still seen as allied with Washington. On Feb. 9, 100,000 people massed outside the steel-plate-covered windows of the U.S. embassy. The march was organized by the Justice Party, whose platform advocates adoption of Islamic law. Although the party won just 1.4% of the vote in 1999, the turnout suggests anti-U.S. sentiment may give hard-liners a broader base from which to operate.

Facing such pressure, could Indonesia morph into a radical Islamic state? There's no immediate danger of that happening. The five parties in the Legislature that call themselves Islamic embrace religious tolerance. In the 1999 elections, parties advocating Islamic law won just 14% of the vote. Nor is there polling evidence to suggest that support for the far right is growing. Megawati's Indonesian Democratic Party of Struggle won a third of the vote in 1999, far more than any other party. The secular Megawati remains the country's most popular politician.

What's more, the Bali attack awakened Indonesians to the presence of dangerous elements. Police arrested 25 suspects and cracked down on members of Jemaah Islamiyah, the fundamentalist group linked to the bombing. On Feb. 3, police on Bintan Island arrested Slamet bin Kastari, a Jemaah Islamiyah leader wanted in connection with an abortive bomb plot against the U.S., British, and Israeli embassies.

Yet there are worrisome signs that radical elements are still very much at work. The morning after Kastari's arrest, a bomb exploded at national police headquarters. Police aren't saying if there was a connection to the arrest, but that's certainly not the kind of publicity Indonesia needs.

Mainstream Islamic parties have been quick to denounce such attacks. But Indonesian political analysts say that in private, many of their leaders pander to radical groups and play up anti-U.S. sentiment. Consider Amien Rais, who heads the 28-million strong moderate Islamic organization Muhammadiyah. In numerous speeches and in meetings with Westerners, Rais has denounced violence. In September, though, he told reporters in Jakarta that the government should not hand over Jemaah Islamiyah leader Abu Bakar Bashir to the U.S., which in October designated his group a terrorist organization similar to al Qaeda. "Ever since the Cold War, the CIA only wants to poke its nose in other countries' affairs," he said.

A month later, Bashir was arrested in connection with the bombings of Christian churches on Christmas Eve, 2000. The police allege at least two members of his group were directly involved in the Bali bombing. Bashir is still being held, but he hasn't been charged in connection with the attack. Rais condemned the bombing, but not Jemaah Islamiyah. He and his associates didn't respond to requests for comment.

Political polling is rare in Indonesia, so it's hard to tell if Muslim parties are gaining popular support. But the rancorous opposition is complicating efforts to stabilize the economy. Since she took office in August, 2001, Megawati and her policy team have surprised skeptics. The central bank cut inflation from 12.5% to 10.3% by tightening the money supply. Foreign currency reserves grew 14%, to $32 billion. As a result, the rupiah has gained 15% in the past year.

Now the government wants to tackle obstacles to business. New foreign investment approvals in last year's first nine months fell by 40%, to $12 billion. Due to "corruption and red tape," says a new World Bank report, it takes twice as long to set up a manufacturing business as it does in China. To boost investment, Coordinating Minister Dorojatun Kuntjorojakti wants to cut bureaucracy, reform tax codes, and upgrade the power grid. "Indonesia can't afford to go slow," says World Bank country director Andrew Steer. Adds the IMF's Citrin: "We have no doubt about the desire of the economic team to do what's right. The only question is their capacity to deliver."

But the government must fend off pressure from powerful vested interests who thrive under the status quo. And if more coalition members use a U.S. war with Iraq to whip up the masses, the fury could be directed at Megawati's policies -- as happened with the recent fuel riots. Even if Megawati wins re-election, she may have to share greater power with Muslim activists or give them a bigger voice in legislation. "The Muslim fold will increase," predicts Jusuf Wanandi, chairman of the Center for Strategic & International Studies in Jakarta. "There's no way to escape that in a democracy." That means Indonesia could face yet another season of turmoil and halting reforms.

By Michael Shari in Jakarta

    Before it's here, it's on the Bloomberg Terminal.