INDONESIA

The second country to go to the IMF for financial aid, in November of 1997, Indonesia under the leadership of President Soeharto, prevaricated, stalled, delayed, changed and twisted like a chameleon, infuriating IMF officials and Western governments alike. At once accepting the strictures of the initial IMF programme approved by the IMF board on November 5, 1997, Soeharto seemingly reversed course without warning, announcing budgetary measures including the reopening of banks which were shut down supposedly as part of that fiscal rationalisation and which were subsequently re-opened.
The same pattern occurred with the IMF demand for the closure of 16 out of the country’s 260-odd banks. Several of these were to re-open, some simply by virtue of changing their name. This was a further issue which could have been better handled by the IMF given that it played an undoubted part in the complete meltdown of the Indonesian banking system as panicked depositors, unsure of which banks were to be closed, withdrew their funds en masse. The issue is not whether the closure of the 16 banks concerned was correct, but rather that the demand for closure should have been pre-empted by a national guarantee by the Indonesian authorities, with multilateral assistance if necessary, of Indonesian banking deposits. The specific disaster which was visited upon the country’s banking system as a result of this demand need not have happened and the IMF and the Indonesian authorities themselves must share the blame for this.
The IMF made further demands in the latter months of 1997 and early January 1998, more specifically concerning the complete dismantling of the state cartels on primary products, such as palm oil, wood and so forth, and the lifting of subsidies on oil, flour and other basic commodities. In the context of free trade theory, this made perfect sense. Yet applying this theory to the case of Indonesia at the end of 1997 and early 1998 was perhaps not best appropriate. In practice, the dismantling of price and trade controls on palm oil resulted in a massive spike in its price, leading to violent bursts of social unrest from a domestic peasantry, already bemused by mounting job losses. In reaction to this, Soeharto then ordered the banning of palm oil exports, in complete breach of the IMF trade requirements. Soeharto’s dealings with the IMF can best be characterised by a combination of expediency and evasion. Oversight b a Western multilateral organisation such as the IMF was certainly not deemed desirable in the first place, but in the latter months of 1997, when the rupiah was in free-fall and Indonesia’s economy was steadily being destroyed on a daily basis, such oversight - and more to the point, financial aid - was deemed necessary.
Evasion was also necessary, in part because many of the IMF programme demands clashed with the financial and economic interests of the Soeharto family, in part because Soeharto was after all the leader of a nation which had rid itself of colonial domination by the force of arms. It is in this context that the January 15, 1998 signing of the second IMF agreement by Soeharto, seemingly cowering before the erect figure of a grim-faced Michel Camdessus should be seen. To many in Indonesia, this was a humiliating replication of colonisation. For many in the West, this may seem an extreme analogy, but it was not the West which was suffering from its greatest economic catastrophe since the war. A leader of Indonesia who could be so humbled by the West, who could be seen dS so powerless to defend his country’s interests was potentially a leader who was dispensable and expendable. Soeharto came to power in 1966, after all, as a result of a military coup - historical purists will point out here that elements of the military deemed leftists staged a coup against the Sukarno regime, possibly aided by the PKI, the Indonesian Communist Party. There is little question however that the Soeharto faction in the military knew ahead of time of such plans, allowed them to be played out, only to use these as an excuse for a military take-over of the country and a bloody putsch of perceived opposition elements, or more specifically anyone who was thought to be a Communist.
Actions by Asian governments emerging from colonial domination and subsequent internal turmoil cannot be seen exclusive to that historical backdrop, particularly those undertaken by the Soeharto government. It is in this context that we find ourselves on January 20, 1998, with Soeharto stunning the world by announcing the appointment of BJ Habibie as Vice President. At the time, the parliamentary confirmation of this appointment through the MPR was merely a rubber stamp. International reaction was at first bemused and then highly critical. As a minister responsible for national industry and technology, Habibie had been responsible for the creation of a number of industrial projects, including a national aircraft manufacturer, using substantial public investment. He was also responsible for the wholesale acquisition of the (rusting) East German military fleet after the unification of Germany and finally for the economic thought process which many dubbed “Habibienomics”, characterised most clearly by the idea of alternating interest rate loosening and tightening.
Rightly or wrongly, his appointment as Vice President was viewed in the West, in the governments of the U.S. and Europe, and in the IMF, as an unmitigated disaster. Soeharto was showing his hand, that he and he alone was the supreme ruler in Indonesia. Yet, the appointment of Habibie had wider implications. As well as being a champion of national industrial projects (however ill-advised given that most of them lost money), Habibie was also an active promoter of “pribumi” (indigenous Indonesians) and Islamic interests. He was after all head of an important Islamist group, the ICMI (Indonesian Association of Muslim Intellectuals). As such, he had reportedly on occasion openly promoted “pribumi” and Islamic interests over those of the Christian religions and Chinese ethnic minorities. His elevation was thus seen also as an elevation of Islam in the national political psyche, an important departure from the previous government’s policies which had brutally if effectively dealt with any Islamist elements deemed fundamentalist or against the binding national ideology of “pancasila”.
Subsequently, elements of the Indonesian society appeared to see this as a green light for the public promotion of ‘pribumi” interests with some calling for the expropriation or redistribution of ethnic Chinese wealth among the pribumis. What had started as an economic recession was rapidly developing nasty and serious sociopolitical and ethnic overtones. While sporadic rioting outside of Jakarta was gradually taking on an ethnic, anti-Chinese flavour, minorities were initially protected by the security forces in the capital itself. Coincidence? Surely not! It was most likely a graphic demonstration by Soeharto again of who was in charge and the chaos that might ensue if that iron grip on control was ever let slip.
Yet, Soeharto had other tricks up his sleeve, on the economic as well as the political side. In particular, he stumbled upon one trick, the idea of a currency board. It is unknown quite how Soeharto came upon this idea, though it seems doubtful that it originated from his own economic and financial technocracy, particularly since the very concept of a currency board necessitates the theoretical elimination of discretionary control by a country’s central bank over its monetary policy, if not the complete elimination of the central bank itself. For a central bank or a finance ministry to suggest such an idea would be tantamount to suicide. Whatever the case, Soeharto’s discovery” of the idea of a currency board coincided with the public promotion of the same idea by a university professor at John Hopkins University in the U.S., one Stephen Hanke. The IMF programme conditions were not only against the financial interests of the Soeharto Family. The full implementation of liberalisation, the shutting down of debt-ridden corporations and banks and the elimination of price controls were tantamount to a demand for the regime itself to commit political suicide given the social and political backlash which would inevitably result from these policies. Yet, Soeharto undoubtedly needed the significant funds attached to that IMF programme. Hence, he needed to be seen to be willing to go along with the programme, thus attracting initial loan commitments, if not actual disbursements from the programme while at the same time playing for time in terms of applying the terms and conditions of the programme, to avoid the worst consequences of these conditions for the regime itself and at the same time to seek a classical, economic alternative to those conditions.
The currency board idea thus suited Soeharto’s objectives perfectly. Hanke was soon invited to Soeharto’s “court” - given that Soeharto seemed in every respect the modern incarnation of a traditional Javanese King, this analogy seems apposite - where one must presume he discussed the intracacies of the currency board concept with the great man and his hangers-on, and its application to the Indonesian situation.
It must also be presumed that the IMF, which seems to deem itself the economic arbiter of the last resort, is not used to or tolerant of economic alternative ideas, to its stated policy recommendations. Certainly, the IMF public reaction to the currency board idea was far from positive, not only because it was deemed unworkable, but because the very fact of an alternative idea was unwelcome. A currency board requires the subjugation of monetary control to a fixed peg or exchange rate, extreme fiscal discipline, the backing of the monetary base by foreign currency reserves and the national resolve to accept that the economy henceforth takes the pain of adjustment rather than the exchange rate resulting from financial over-valuation. On its own, Indonesia did not have the reserves to back its monetary base commitment to a currency board. In order to do so, it would need extra funds from the international community and the IMP nas at that time ideologically opposed to the idea of a currency board in Indonesia since this ran in direct opposition to its existing policy prescription. Even if it had the necessary funds for this purpose, given the shattered state of its economy and more importantly of its banking sector, the market would most likely test Indonesia’s commitment to a currency board, necessitating initially sharply higher interest rates to defend the currency board peg. Those who argue that Indonesia’s banking system could not under any circumstances have withstood the requirements of a currency board system ignore the precedent of Argentina whose banking system was in similarly perilous state before the implementation of a currency board in 1991 and equally the fact that the discipline of the currency board saved both the economy and the financial system of that country.
So much for theory. There can be little doubt that Indonesia, unlike in the case of Argentina, did not have the resolve to follow through on the currency board idea. When Soeharto learned the requirements of a currency board, he most probably would have dismissed the idea out of hand, albeit privately given that the stratospheric interest rates needed to defend the currency board initially would have caused potentially explosive social unrest. The best that can be said of the currency board idea in Indonesia was that it could have worked theoretically if the government had had the unswerving resolve to implement it fully, but in the end Soeharto rejected the idea for very practical reasons. In the meantime, however, Soeharto pretended to continue to consider the idea. This served two useful purposes. On the one hand, it kept the IMF occupied, and away from demanding the implementation of their own programme conditions. On the other, it had the hitherto unexpected benefit of causing the Indonesian rupiah to stabilise and even strengthen. The rupicth had by that time hit a distant and record low of 17,000 to the dollar (as against around 2,400 before the devaluation), only to slowly crawl its way back from that abyss after the signing of the second IMF agreement. At a time when it was still trading around 12,000 to the dollar, official leaks suggested that a currency board might be implemented at between 5,000-8,000 to the dollar, immediately causing currency traders to cover short rupiah, long dollar positions, by buying back the rupiah, just in case such a seemingly far fetched idea was actually implemented. This provided at least some degree of platform for economic stabilisation while Soeharto tried to keep the IMF at bay.
While the Western media speculated that Soeharto might actually implement a currency board at an exchange rate of 5,000 to the dollar, as per official leaks, in order to bail out much of the Indonesian corporate base linked to the First Family - a policy which would have seemed eminently reasonable on the face of it to a javanese King - it seems likely that Soeharto, at least in the latter stages after he had been made to understand its implications, had no intention whatsoever of actually implementing a currency board given the likely consequences to the banking system and the country as a result of yet higher interest rates. Soeharto was thus, yet again, the Javanese puppet master in an elaborate puppet game. Neither Hanke nor Soeharto were to remain unscathed from this episode. In the case of the former, he was publicly castigated by many commentators, most famously by the MIT Professor Paul Krugman as the “rupiah Rasputin”, a description seemingly aimed more at capturing the media’s headlines rather than adding to the level of economic debate.
Meanwhile. Soeharto continued to court alternatives to the IMF In March 1998, Habibie toured Japan, pleading for financial aid. The then Japanese Prime Minister Hashimoto followed this up with a visit to Jakarta in April, bringing commitments of financial and food aid, notably of basic commodities such as rice. Japan had a major vested interest in not allowing Indonesia to go under since its banks were thought to be exposed in Indonesia to the tune of USD24 billion. Japan’s trading houses were thought to be even more exposed than their Japanese banking counterparts. Japan’s commitment to helping Asia up until then had met with significant controversy. In mid-1997, it had proposed an idea subsequently to be dubbed an Asian Monetary Fund, reflecting a reserve facility upon which Asian authorities could draw in times of need. This idea had gone down like a lead balloon in Washington, publicly because there was no need to replace the existing facilities of the IMF, and privately because it represented a fundamental challenge to U.S. dominance of the global financial system. Japan’s loans to Indonesia and Thailand and the subsequent Miyazawa Initiative, named after Finance Minister Kiichi Miyazawa and reflective of this initial idea of a Japanese-dominated and created loan fund for Asian countries in need, were controversial with Western governments because they too represented a key challenge to Western domination in Asia. Yet, they were surely reflective merely of what the West had long since demanded, namely a more assertive Japanese presence on the world’s political and financial stage.
Japan’s loans were the catalyst for donations from other Asian countries, but though they delayed the IMP’s demands on Indonesia, they did not serve to deflect them. The IMF continued to demand its trademark brand of fiscal and monetary austerity coupled with market opening and supervisory regulations. Without these, IMF loan commitments would not become actual disbursements. Soeharto’s delaying tactics had frustrated and fooled many, but they did nothing to solve the underlying problem. The Indonesian corporate base was to all intents and purposes completely bankrupt, its banking system in tatters. Unemployed urban workers were being herded into trucks by the military in order to avoid major public demonstrations or unrest. Soeharto faced two alternatives, both potentially unpalatable. One was to give in completely to the IMF demands and thus risk complete social and political disintegration and more importantly his own removal. The other was not to give in and to continue to delay, thus getting IMF and international loan commitments but few actual disbursements. The country would thus continue to stagnate, more companies would continue to go bankrupt. In the end, Soeharto seems to have chosen a combination of going down fighting, while protecting his own.
In this regard, Soeharto’s last hurrah was his move on May 5, as he left for an emerging market summit in Cairo, to eliminate all price controls on basic commodities for a year which he had up until then been delaying on the view that such price control elimination would be socially disastrous. The result should have been predictable. Within a week, Jakarta’s Chinatown district was in flames as the city’s primarily Muslim disadvantaged used the perceived wealthier ethnic Chinese Indonesians as the scapegoats of their own misfortune. At the time, several newswires reported the suspicion that elements of Indonesia’s special forces, then under the command of Soeharto’s son-in-law Lieutenant General Prabowo, were responsible for fuelling and inciting the riots which wracked Jakarta in May of 1998, involving the killing and raping of ethnic Chinese. Subsequently, an Indonesian military court ruling confirmed this reported suspicion. In total, around 1,120 people died in the May riots, including several hundred looters who perished in a building which they were in the process of looting and which was mysteriously set on fire. Subsequently theories abounded that Prabowo had been attempting a coup while Soeharto was away. This view - denied by Prabowo - gained prominence because ABRI (Armed Forces of Indonesia) Commander General Wiranto was also away from Jakarta at the time. Whatever the case, Wiranto returned and restored order to the streets of Jakarta through a combination of stern orders that looters would be shot on sight, and attempts to negotiate with demonstrators and student groups. When Soeharto returned to Jakarta, his capital was effectively under martial law. Once more, he had demonstrated that he - and by implication the military from which he came - were “the only game in town”. Yet again, he had “proved” himself indispensable to the West (i.e. the IMF) in keeping Indonesia in one piece. Yet, the underlying fundamental condition of Indonesia continued to worsen. Indeed, that degree of deterioration had just been multiplied several times over as a result of the May riots. The essential calamity which was destroying the very fabric of Indonesian society, let alone its economy, could not be outrun by Soeharto’s delaying tactics.
On May 17, Soeharto had claimed emergency powers from the MPR, only for House Speaker Harmoko to call for Soeharto’s resignation the following day. Daily student demonstrations climaxed in the storming of the parliament itself. ABRI Commander General Wiranto had plenty of opportunity to shed significant blood if he had wanted to, but instead he seemed reluctant to fight such public expression of discontent through force of arms on the streets of the capital.
The bottom line had been that Indonesia, its fiscal and current accounts badly holed below the water line was sinking fast and needed money immediately to plug the gaps. With Soeharto in power, Indonesia was unlikely to get it. This realisation now coincided with widespread public demands for Soeharto’s resignation. On May 20, the unthinkable happened. Soeharto stood before the world’s media and announced his resignation, handing over to his Vice President BJ Habibie. The Western media recounted the end of a 32-year reign, as if the old man, now stripped of formal office, was also stripped of all influence. This was very far from the truth and to many a case of wishful thinking. Habibie was after all like an adopted son to Soeharto, dating back to the time when Soeharto as a young army officer had stayed at the Habibie home in the outer islands. Despite having his own financial resources, Habibie owed his elevation in government circles almost entirely to his “father” figure. To then say that Habibie mounted a coup against Soeharto is thus nonsense. General Wiranto almost let slip the reality when he stated publicly that no member of the Soeharto Family nor their assets would be allowed to come to harm, this while the houses of rich ethnic Chinese who had done much to finance the regime were allowed to be ransacked and burned, It is in this context that the initial elevation of Habibie to Vice President should be seen. Yes, he was put in place as a transition President, but also one who would protect the interests of his “father” Soeharto, either deliberately or otherwise. In the Javanese puppet game, Habibie played his part, an important part to be sure, but the puppet-master had not changed. Soeharto still pulled the strings. To be sure, there had to be sacrifices, examples which could be held as proving the new administration’s reforming spirit. Right after Habibie was handed the reigns of power (subsequently to be confirmed by a vote of parliament), he removed from ministerial office ‘Bob” Hasan, Soeharto’s golfing partner, and “Tutut”, his daughter, a very public gesture of reducing the influence of the First Family. While filling technocratic positions with his own supporters, Habibie did everything possible in the public arena to please the U.S. administration and the IMF, promising free and fair elections the following year. He made the Bank of Indonesia separate and independent from the government by an act of parliament. He supervised the setting up of the Indonesian Banking Restructuring Agency and the Indonesian Debt Restructuring Agency. Western officials must have been pleasantly surprised. Certainly, the markets were. In truth, however, little had changed. Soeharto still held considerable influence, if only by his sheer presence and force of personality. The interests of his family had not been realistically threatened let alone expropriated. Meanwhile, the economy continued to deteriorate, the debt burden to get ever larger.
The first effort in Tokyo in May 1998 to restructure and rollover foreign bank loans to the domestic banking system had seen its talks come to nothing. Subsequently, in June of that year in Frankfurt, an agreement was tentatively reached with Indonesia’s leading creditors, allowing a 3-5 year grace period for the repayment of the principal. Indonesian Debt Restructuring Agency (INDRA) was set up to provide foreign currency, though in a crucial departure from the Mexico 1982 bailout INDRA did not guarantee to subsidise the translation exchange rate to be used for debt restructuring. There was thus little incentive for an Indonesian corporation or bank to use INDRA.