JAKARTA (Reuters) - When President Susilo Bambang Yudhoyono came to power in Indonesia vowing to stamp out corruption, sceptics scoffed it was an impossible task in a country where bribes are demanded from the cradle to the grave.
Nearly two years down the road, Yudhoyono has demonstrated his resolve with a high-profile anti-graft campaign that has sent a host of officials from a former religious affairs minister to the governor of Aceh province to prison on corruption charges.
But, if his efforts are winning laurels overseas, at home the campaign is causing more economic problems than it solves, paralysing decision-making at the national and provincial level.
Stringent new laws on transparency in bidding for infrastructure projects, procurement of machinery and spending of state funds have backfired, impeding reconstruction in the earthquake-hit Java Island and strife-torn Aceh.
"Fighting graft is important. I think this determination to do something does matter," said Ramya Suryanarayanan, an economist with financial analysis firm IDEAglobal in Singapore.
"(But) something has to be done about this fear factor -- fear of getting involved, finding yourself behind bars -- and all that's doing to projects," she said.
Anti-corruption watchdog Transparency International ranks Indonesia among the world's most corrupt states -- equal 137th out of 159 countries, alongside Liberia, Iraq and others.
Indonesians are used to shelling out for everything from getting a birth certificate to ensuring the site of their future grave isn't given to someone else.
But fighting the scourge is having unforeseen consequences.
Not least, the paralysis in decision-making is being blamed for a big shortfall in public spending in 2005.
The government had a budget deficit of 14 trillion rupiah ($1.5 billion), much lower than the forecast 25 trillion because of low spending. Not much has been invested in the first quarter of 2006, either.
There are clear economic risks from the failure to spend.
"It has meant that government spending at both the central and regional levels has failed to provide support to domestic demand, which would be appropriate given the current softness of activity," the International Monetary Fund said in mid-June.
Annual economic growth slowed to 4.6 percent in the first quarter of 2006 from 4.9 percent the previous quarter after a sharp rise in fuel prices in October and a jump in official interest rates, now among Asia's highest at 12.5 percent.
Bambang Prijambodo, a director at the state planning agency (Bappenas), blamed underspending on the fact that officials were frightened actions taken in good faith might contravene the new rules in some way.
"If they do nothing, they won't face any risk of prosecution, so it's better not to make any decisions," he said.
Higher fiscal spending is badly needed to support the economy as household consumption has been hit by the fuel price rises and high interest rates while foreign investment remains weak.
Total investment accounted for less than a fifth of gross domestic product in Asia's fifth-largest economy last year and officials were hoping for better this year.
Household consumption accounted for 60 percent of GDP in 2005 but inflation, led by fuel prices, could cut that and weigh on growth this year.
Foreign companies need to be persuaded Indonesia is changing before they will step up investment in its oil sector and roads. Foreign direct investment in the first quarter of 2006 was just $2.6 billion, roughly half of what China gets every month.
Economists see another risk -- that of government spending being bunched up and pushed to the end of the year.
"If they do that, it will push up inflation and make it harder for Bank Indonesia to cut interest rates," said Andy Rahmat, member of a parliamentary committee for economic affairs.
The economic pain has prompted a debate on whether the government should put economic growth first, since prosperity should make it easier to curb corruption, or fight graft first to cut the cost of doing business and thus boost economic growth.
President Yudhoyono has no misgivings.
"There have often been suggestions that this graft fight be put to an end. But I say no," he told government officials in the South Sumatran city of Palembang this month.
His stand is applauded by many Indonesians, who see corruption as a big factor behind poverty, religious radicalism, separatism and political instability in the world's most populous Muslim nation.
"This graft fight is a bitter choice but it has to be done. It is critical for the country's long-term stability," said Syafii Ma'arif, respected moderate Muslim scholar and former head of Indonesia's second largest Muslim group, Muhammadiyah.
(Additional reporting by Muhamad Ari)
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