EAST ASIA: A DECADE AFTEREconomic & Political Weekly december 15, 200779Ten Years After: Impact of Monetarist and Neoliberal Solutions in Indonesia R Ramli, P NuryadinThe financial disaster that erupted in east Asia 10 years ago had a devastating impact on Indonesia as the economic contraction was the worst among all the affected countries. Indonesia experienced the entire range of economic crises, from an exchange rate collapse to a liquidity crunch and banking sector breakdown, leading ultimately to bankruptcy in the corporate sector. This paper reviews the social and economic costs of policy errors including the bitter experience with the International Monetary Fund, which, in fact, escalated the crisis. The efforts to bring an end to the IMF programme were thwarted by the actions pushed by the new era economic group that deepened the dependence on international debt.The epithet of “The East Asian Economic Miracle” bestowed upon some Asian countries by the World Bank was in the event not strong enough to protect them from the crisis that befell the region 10 years ago. The exchange rate crisis that emerged first in Thailand had a devastating impact on the econo-mies of Malaysia, Korea, Indonesia as well as Thailand. It is re-grettable that the economic contraction suffered by Indonesia was much worse than in the other affected countries. Indonesia experienced the entire cycle of economic crises from exchange rate collapse to a liquidity crisis to a banking crisis and finally generalised bankruptcy in the corporate sector. In 1998 the Indo-nesian economy contracted by 12.8 per cent, the worst economic reversal in the world outside of the former Soviet Union and the eastern bloc.At the time government bureaucrats blamed the crisis on external factors. But this is more of a reflection of their refusal to take responsibility for their role in the crisis, and their eager-ness to find a scapegoat. Events in Thailand did give rise to the initial shock, but subsequent developments were a consequence of structural weaknesses in the Indonesian economy. Moreover, the impact of the crisis was made much worse by the failure of policymakers to anticipate it, and a series of misjudgments and policy errors as the crisis unfolded. The social and economic costs of these policy errors were mas-sive. Tens of millions of people lost their jobs and half of the pop-ulation fell below the poverty line. The riots and looting of May 1998 were a direct result of the breakdown of the economy. The cost of recapitalising the banks reached Rp 650 trillion [including Bank Indonesia Liquidity Credits (BLBI)], plus new public sector foreign borrowing. The domestic and foreign debt from this period remains a burden on the national economy until today. These are bitter memories, but there is much that we can learn from this tragic experience, especially in the context of Indonesia’s continuing economic vulnerability. 1 ThePre-CrisisEconomyIndonesia enjoyed moderate rates of economic growth prior to the crisis.1 From 1970-96, real growth of gross domestic product (GDP) averaged 6.7 per cent per annum.2 But this moderate eco-nomic growth concealed some structural weaknesses that risked destabilising the national economy. These weaknesses were, among others:Cross Ownership and Cross Management in the Financial Sector: One specific policy change that had a huge impact on the financial sector in the early 1990s was the October 1988 de-regulation package, better known as “Pakto 88”. An important R Ramli (cryptrr@gmail.com) is a former coordinating minister of economics of Indonesia and now heads the ECONIT advisory group. P Nuryadin(pny235@gmail.com) is a senior researcher at ECONIT.
EAST ASIA: A DECADE AFTEREconomic & Political Weekly December 15, 200781Malaysia met these three criteria, and therefore needed to take pre-emptive action. To reduce the current account deficit and overvaluation of the rupiah, the ECONIT advisory group at the end ofNovember 1995 recommended that Bank Indonesia (BI) should allow the rupiah to depreciate by at least 16 per cent in 1996 to forestall a speculative attack on the currency. Of course the deprecia-tion would have to be carried out gradually and in stages so as not to trigger speculation against the rupiah. Yet this recom-mendation was ignored and in fact the opposite policy imple-mented, namely, a deceleration of depreciation (3.6 per cent) by end 1996. In other words, the extent of overvaluation of the rupiah actually increased, and with it the vulnerability of the Indonesian economy. ECONIT’s Economic Outlook 1997 published on November 5, 1996 delivered the next set of warnings. ECONIT concluded that 1997 would be a “year of uncertainty” for the economy and cor-porate sector in Indonesia because of the numerous political and economic problems facing the country.ECONIT’s analysis dif-fered markedly from that of the International Monetary Fund (IMF), World Bank (July 1997) and investment banks, which still presented highly optimistic forecasts for Indonesia in 1997 just moments before the onset of the crisis.In line with this analysis,ECONIT recommended that the private sector should consolidate and strengthen the corporate financial structures to reduce over-leverage. These precautions were necessary to reduce exposure to the economic and politi-cal risks in 1997. Managers who reduced leverage and reinforced their corporate financial structures were much better able to pro-tect their businesses from monetary shocks. Unfortunately, these warnings were ignored. ECONIT’s appre-hension regarding the “gathering clouds” in 1995 had heightened into concerns of a full-blown monetary crisis by August 1997. In 1998, the gathering clouds released a hail storm, the impact of which fell upon all of the Indonesian people.3 PolicyReponseIntensifiesCrisisThe exchange rate crisis was impossible to avoid in the end. Through August 1997, the value of the rupiah fell about 18 per cent against theUS dollar. Unfortunately, the response of the monetary authorities to the depreciation was panic. Bank Indo-nesia, at the time led by J Soedradjad Djiwandono, had in fact applied a “super tight monetary policy”. In the Economic Outlook 1998 published on November 5, 1997, ECONIT called this “The Tight Money Beating 97” (GebukanKUSUT 97) that would give rise to a liquidity crisis that was more dangerous than the cur-rency crisis itself. The potential impact of the liquidity crisis on the wider economy was far greater, and the ultimate economic consequences could be devastating for every firm and household in Indonesia. The panicky response of the monetary authorities undermined market faith in the rupiah. In the midst of a crisis, psychological factors are more important than market fundamentals when it comes to determining the exchange rate. The impact of the 1997 tight money policy was even harsher than that of the “Sumarlin Shock II” in 1991 because the latter incident only targeted the money supply while allowing the market to set interest rates. But the 1997 tight money policy attempted to control three things at the same time, namely: the money supply, the price of money and the allocation of money. The impact of this attempted “triple fix” was nothing short of disastrous.It is not a coincidence that the rupiah fell to a new low on the morning of October 6, 1997 (Rp 4.0 per US $), reflecting the mar-ket’s negative perception of the policy intervention of the mon-etary authorities. This overshooting of the appropriate level of the rupiah against the dollar was a vote of no-confidence in the monetary policies that had just been adopted. The World Bank and even the government itself stated pub-licly that the country was experiencing a “crisis of confidence”. These pronouncements were self-destructive in that they under-mined the very confidence that the authorities were trying to re-establish. The comments also reveal the extent of the policy confusion that had paralysed the government and indeed the international organisations. A financial or cash-flow crisis is a much simpler problem, and one that can be resolved through the extension of new borrowing to restore liquidity to the system. But a crisis of confidence suggests that the markets have lost faith in the monetary authorities and the economic policy in general. Under these conditions new lending simply provides additional ammunition for the speculative attack on the currency. Confi-dence can only be restored by putting in place credible policy-makers and credible policies to convince the markets that the tide had changed, and that speculation against the currency had become more risky. It is interesting that 10 years after the event J Soedradjad Djiwandono (governor of Bank Indonesia 1993-98) admitted that monetary policy at the onset of the crisis was excessively tight [InfoBank 2007]. In an interview published inInfoBank magazine in 2007, Djiwandono said that “monetary tightening in the third and fourth week of August 1997 was indeed excessive”. 4 Enter IMF: Beginning of New DisasterReflecting the feelings of inadequacy and self-doubt that emerged among policymakers during the crisis, some officials began to talk openly about the need to ask for the assistance of theIMF. Newspapers in Indonesia and abroad advised Indonesia to immediately request a loan from the IMF. According to these official and the mass media pundits, only anIMF loan could help Indonesia recover from the monetary crisis. ECONIT’s Public Policy Review (EPPR) of October 8, 1997 warned that inviting theIMF would only push Indonesia into a deeper crisis. ECONIT compared Indonesia to a patient in needof hospitalisation because of some economic risks and because of the accumulation of financial and monetary mis-judgments and policy errors. But Indonesia’s economic funda-mentals were much better than those of Mexico and Thailand, and therefore Indonesia did not need to be treated in the inten-sive care unit. In the second week of October 1997, ECONIT divided Indone-sia’s crisis into four stages. At the time, Indonesia was still in the early phases of stage 3. Many options were still available short of IMF intervention.
EAST ASIA: A DECADE AFTERDecember 15, 2007 Economic & Political Weekly82In the same publication, ECONIT also argued that there were two possible explanations for why Indonesia was being told to invite theIMF even though the situation did not warrant a trip to the intensive care unit. The first possibility was that the groups that were urging Indonesia to seekIMF assistance (Widjoyo and his colleagues) in fact wanted Indonesia to enter into a more dangerous stage of the crisis, to experience a sharper economic decline with wider social and political implications. The recommendation to allow cross defaults to occur so as to teach the borrowers a lesson suggests pettiness and a disregard for the fate of the nation, since cross-defaults would certainly leave Indonesia no option but to go to the IMF. It was well understood at the time that cross defaults would result in sudden and massive capital outflows, leaving Indonesia dependent on the IMF for access to foreign exchange. The second possibility is that the people recommending IMF involvement did not understand the consequences of doing so or the historical experience of countries that had borrowed from the IMF. Clearly they were not sufficiently aware of the impact of IMF loans in the countries affected, and that the IMF programmes had resulted in a dramatic slowdown in economic growth, a sharp re-duction in purchasing power among consumers, and an increase in poverty. TheIMF was not a “saviour”, but rather a “surgeon” that would carry out an unnecessary emergency room amputa-tion and then put the patient on a strict diet with long term con-sequences [EPPR 1997: 3]. Benefit to LendersIndonesia’s economic turbulence had resulted in serious losses for international creditors, since the fall in the value of the rupiah had made it impossible for domestic borrowers to meet their obli-gations. The use of IMF loans only to enable Indonesian debtors to make principal and interest payments would only benefit inter-national lenders. But in the long run it is the Indonesian people that would have to pay back the IMF in the form of an excessive contraction in aggregate demand. Only with reduced consump-tion could the economy produce the financial surplus needed to repay the country’s debt to the IMF[ibid: 4]. In this connection, the following question arises: “Who bene-fited from the advice to call in theIMF – international creditors or the Indonesian people?” Monetary contraction would certainly save some creditors from losses but would also result in the loss of purchasing power, a shift in the structure of asset ownership and the acceleration of “economic condemnation” of the small and medium-sized enterprises. The small and medium-scale businesses cannot withstand the liquidity problems stemming from an extended monetary contraction, causing bankruptcy rates among these firms to increase. In fact the government had begun to take some positive steps to bring the country out of the monetary crisis. The minister of the state secretariat Moerdiono, on the orders of president Soehar-to, had requested corporate borrowers that had not hedged ex-change rate risk to queue for access to foreign exchange (Sep-tember 24, 1997). But unfortunately the “Berkeley mafia” had intentionally ignored this order to coordinate repayments of unhedged corporate borrowers. It is no surprise that unhedged private debtors rushed into the market to buy foreign exchange to repay their loans, with the result that in early October the ex-change rate plummeted [ibid]. Suppose some corporate borrowers are finding it difficult to roll over their loans. The government can help them by forming a private sector negotiating committee to attempt to convert the debt into equity (debt to equity conversion/swap). Debt to equityswaps achieve three things: (i) over-leverage in the cor-porate sector is reduced; (ii) corporate financing is strengthened; (iii) in many cases the quality of management improves with the involvement of international managers.Still other options were available, which suggests that the IMF was called in too quickly. Lack of self-confidence and indecision paralysed the government precisely at the time when decisive action was needed. In economics, as in politics and war, the quality of leadership is tested during times of crisis. The experiences of other countries have shown that many of the IMF’s patients recover briefly only to experience a relapse and revert to being a patient. There are many examples in Africa and Latin America of how the IMF applies ineffective, generic prescriptions. YetECONIT’s concerns were ignored. The government, repre-sented by the minister of finance Marie Muhammad andBI gov-ernor Sudradjad Djiwandono insisted on signing the first letter of intent (LoI) with theIMF on October 31, 1997. At the request of the Berkeley mafia led by Widjojo Nitisastro, president Soe-harto signed the second LoI in January 1998 witnessed byIMF Managing director Michel Camdessus. In fact, the head of state rarely signsIMF agreements, which are typically signed by the minister of finance or head of the central bank. But the Berkeley mafia purposely talked president Soeharto into signing so that later they could dissociate themselves from the deal. IMF Worsened CrisisThe involvement of the IMF broadened and deepened the crisis. As a consequence of misdiagnosis and its incorrect prescription, the Indonesian economy contracted in 1998 by 12.8 per cent. Of course even without theIMF Indonesia would have suffered an economic crisis, but most likely on a smaller scale – economic growth of -2 to 0 per cent – in 1998. The policy recommendations of the IMF pushed Indonesia into a more serious crisis. For example, the liquidation of 16 banks in November 1997 triggered a bank run on tens of banks including BankBCA and Bank Danamon, precipitating the collapse of the national banking system and the sinking of the rupiah.The economic and social costs of the crisis led to the IMF-provoked riots of May 1998. In many cases in Latin America and Africa the involvement of the IMF andIMF recommendations have triggered mass demonstrations, riots, loss of life and the fall of governments. In addition, and in the Indonesian case, the in-volvement of the IMF has forced tens of millions of people out of work, bankrupted the private and public sectors, and imposed long-term costs on the economy such as the more than Rp 600 trillion given over to recapitalise the banks and tens of billions of dollars in new international debt.
EAST ASIA: A DECADE AFTERDecember 15, 2007 Economic & Political Weekly84debt reached $ 13 billion (Rp 130 trillion). Debt service payments in this year were more than three times as large as salaries for the entire civil service and military, and more than eight times the size of the education budget. The size of the domestic debt is closely connected to BI’s monetary policy. With the encour-agement of theIMF, BI was certain that control over inflation could only be achieved through tight monetary policy and high interestrates on Bank Indonesia Certificates (SBIs). But this dis-regarded the obvious fact that much of the inflation recorded during this period was a direct result of price hikes implemented by the government. Inflation was not in this instance simply a monetary phenomenon. Moreover, an unintended consequence of BI’s tight money policy was a mounting burden on the gov-ernment budget, as debt service payments were linked to domestic interest rates. At that time, every one per cent increase in theSBI rate resulted in an increase in the government deficit of Rp 2.3 trillion.Difficult DilemmaWith such a large burden on the state budget, the government was confronted with a difficult dilemma. Unpopular measures were needed to reduce the deficit, many of which would make life difficult for millions of Indonesians. In addition to raising taxes, electricity and fuel prices, the government was under in-tense pressure to sell state assets as quickly as possible and at bargain basement prices. The case of Bank Central Asia(BCA) in 2002 is an interesting example. With a target price of Rp 5 trillion, the government would still have to carry the burden of interest payments onBCA recapitalisation debt of between Rp 7 and 8 trillion per year, assuming no change in the government’s position on recapitalisation debt. The policies of the New Order economic mafia, supported by theIMF, relied on debt rather than investment for development and thus drove the economy into a deeper debt trap. The IMF’s misdiagnosis, forced on Indonesia, led to the government assum-ing responsibility for an additional debt burden that should have been shouldered by the private sector – that is, the debt incurred by the private sector from Bank Indonesia Liquidity Credits (BLBI) of Rp. 144 trillion and bank recapitalisation. Indeed the misuse of BLBI is the largest financial scandal in the nation’s history.5.1 Policy Change Blocked by MythsIn 2002, economists grouped together as Tim Indonesia Bang-kit (TIB) recommended that the government immediately can-cel the IMF programme. We also suggested alternative policies to accelerate economic growth after the discontinuation of the IMF programme. Unfortunately, our efforts to bring an end to theIMF programme were blocked by the Berkeley mafia, which put forward several myths about the IMF and Indonesia’s policy choices. These myths of the new order economic mafia deepened Indonesia’s dependence on international debt. The first myth is that IMF programmes strengthen investor confidence in Indonesia. After so many LoI and seven years under IMF supervision, investor confidence in Indonesia is still not yet restored. The main problem is not the presence or absence of the IMF, but rather political stability, physical security and the rule of law. If these three factors are present, then investor confidence will increase with or without theIMF. The second myth is that IMF loans lead to inflows of private capital. But in fact the opposite has occurred. Under Indonesia’s variousIMF programmes the country has experienced a decou-pling of multilateral and private capital inflows: indeed, private capital has left Indonesia (see Figure 3). Once again, the main reasons are political stability, security and rule of law.The third myth is that the IMF can stabilise the value of the rupiah. This myth has become something of a joke among Indonesians, who know the opposite to be true. Since October 1997, every time anIMF team has come to Jakarta the value of the rupiah has fallen. And on each occasion, BI has been forced to intervene to strengthen the rupiah at a cost of millions of dollars. In general, as noted by Didik Rachbini, the relationship between theIMF and the value of the rupiah is asymmetrical. When the IMF makes positive statements about Indonesia the rupiah does not strengthen, but when the IMF criticises Indonesia the rupiah falls. The strengthening of the rupiah in the first half of 2002 was not a result of the IMF’s performance but rather the weakening of theUS dollar against major world currencies. Another factor was political stability as president Megawati avoided controversy and political parties agreed to stabilise the political situation in the lead up to 2004. The fourth myth is that theIMF could collude with other creditors to deny credit to countries that do not take on IMF pro-grammes, and extend credit to countries that do. This ignores the fact that each creditor has its own strategic and economic inter-ests in Indonesia. At the time that I was coordinating minister of the economy, we signed loan agreements with the World Bank, Japan and the Asian Development Bank even though the IMF letter of agreement had not been finalised. Indeed, many official creditors also view the IMF as too obstinate and object to roll-ing conditionalities inIMF programmes. Creditors are aware that collusion amongst themselves could result in cash flow problems in borrowing countries and even default, which would not be in their interest. These myths were spread continuously by the new order economic mafia to the point that the public was persuaded that without theIMF the country would fall into bankruptcy and break into pieces. But Malaysia overcame the crisis without anIMF program. The Thaksin government in Thailand did not renew its IMF programme, and Thailand did not fall to pieces. Figure 3: Net Private Capital (US $ million)Source:Statistik Ekonomi Keuangan Indonesia Okt 2003, Bank Indonesia.1998 1999 2000 2001 2002–1.74–8.25–10.00–9.99–13.85
x Manuf 
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Coffee 222 Tin 166 Aluminium 110 Plywood 80
-18.7 -12.5 -12.1 -11.1 -10.8 -6.4 -2.7 
