Economics (Indonesia)
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Reference: https://en.wikipedia.org/wiki/1997_Asian_financial_crisis#Indonesia
In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade
surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good
banking sector. But a large number of Indonesian corporations had been borrowing in U.S. dollars. During
the preceding years, as the rupiahhad strengthened respective to the dollar, this practice had worked well
for these corporations; their effective levels of debt and financing costs had decreased as the local
currency's value rose.
In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah currency
trading band from 8% to 12%. The rupiah suddenly came under severe attack in August. On 14 August
1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement.
The rupiah dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was
sinking further amid fears over corporate debts, massive selling of rupiah, and strong demand for dollars.
The rupiah and the Jakarta Stock Exchange touched a historic low in September. Moody's eventually
downgraded Indonesia's long-term debt to "junk bond".[31]
Although the rupiah crisis began in July and August 1997, it intensified in November when the effects of
that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars
had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying
dollars through selling rupiah, undermining the value of the latter further. In February 1998,
President Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono, but this proved insufficient.
Suharto resigned under public pressure in May 1998 and Vice President B. J. Habibie was elevated in his
place. Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2,600 rupiah to 1
U.S. dollar.
The rate plunged to over 11,000 rupiah to 1 U.S. dollar on 9 January 1998, with spot rates over 14,000
during 23–26 January and trading again over 14,000 for about six weeks during June–July 1998. On 31
December 1998, the rate was almost exactly 8,000 to 1 U.S. dollar. Indonesia lost 13.5% of its GDP that
year.
The crisis also brought independence to East Timor.
Reference: http://www.wright.edu/~tdung/asiancrisis-hill.htm
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Indonesia authorities also initially respond with something less than full commitment to that country’s
financial crisis. Following speculative selling, the Indonesia currency, the rupiah, was uncoupled from its
dollar peg and allowed to float on August 14th, 1997. The rupiah immediately started to decline, as did the
Indonesian stock market. By October the rupiah had dropped from $1=Rp2,400 in early August to
$1=Rp4,000, and the Jakarta stock market index had declined from just over 700 to under 500. At this point
the now desperate Indonesian government turned to the IMF for financial assistance. After several weeks
of intense negotiations, on October 31st the IMF announced that in conjunction with the World Bank and the
Asian Development Bank it had put together a $37 billion rescue deal for Indonesia. In return, the
Indonesian government agreed to close a number of troubled banks, to reduce public spending, balance
the budget, and unravel the crony capitalism that was so widespread in Indonesia.
The initial response to the IMF deal was favorable, with the rupiah strengthening to $1=Rp3,200. However,
the recovery was short lived. As November lengthened so the rupiah resumed its decline in response to
growing skepticism about President Suharto’s willingness to take the tough steps required by the IMF.
Moreover, currency traders wondered how Indonesia was going to be able to deal with its dollar
denominated private sector debt, which stood at $80 billion. With both the economy and exchange rate
collapsing, there was clearly no way that private sector enterprises would be able to generate the rupiah
required to purchase the dollars needed to service the debt, and so the decline feed on itself. In December
Moody’s, the US credit rating agency, feed fuel to this fire when it downgraded Indonesia’s credit rating to
junk bond status.
On January 5th 1998 President Suharto seemed to confirm the skepticism of currency traders when he
unveiled Indonesia’s 1998-99 budget. The budget immediately came in for criticism because it made
optimistic assumptions about Indonesia’s economic growth rate in 1998. It projected GDP growth at 4%,
inflation contained at single digit levels (in 1997 it was around 20%), and assumed a rupiah-US dollar
exchange rate of $1=Rp4,000 (the rupiah closed 1997 at an exchange rate of $1=Rp5,005). Moreover, no
plans were announced to abolish the lucrative state licensing monopolies that had benefited his family and
friends. An "unnamed" IMF sokesman informed the Washington Post that the Indonesia government did not
seem to be following through on pledges to restructure the economy and warned that the IMF might hold
back funds. International investors and currency traders responded by selling their rupiah holdings, or
selling the rupiah short, and the exchange rate plunged through the floor, hitting $1=Rp10,000 a few days
later.
At this point IMF officials, together with US deputy Treasury Secretary Lawrence Summers, made a second
visit to Jakarta to "re-negotiate" the IMF terms of agreement. On January 15th they reached a revised
agreement which committed Indonesia to a tough budget. Among other things, this pledged budget cuts,
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including cuts in sensitive energy subsidies, trade deregulation that would wipe out many of the business
privileges enjoyed by Suharto’s family and friends, and accelerated structural reform of the banking sector.
Whether Suharto will follow through on these commitments, however, remains to be seen. On January
20th the 76 year old President announced his intention to run for a seventh term as President. The outcome
does not seem to be in doubt, since the election in undertaken by hand picked delegates, and Suharto
faces no opponent. The rupiah, meanwhile, which was trading at around $1=Rp8,5000 just before the
announcement, dropped sharply, reaching an all time low of $1=Rp14,500 on January 22nd, 1998 before
clawing its way bask up to $1=Rp12,5000.
The sharp drop reflected two concerns. First, fear that Suharto’s apparent unwillingness to step down in the
face of an economic collapse may lead to social breakdown and political violence in Indonesia. Second,
growing realization that hundreds of Indonesian businesses were now technically insolvent and would not
be able to pay back the estimated $65 billion of dollar denominated debt they owed without substantial debt
restructuring and rescheduling of the debt payments. The IMF deal, for all of its good points, had not
addressed this critical issue.
Rererence: https://www.imf.org/external/np/exr/ib/2000/062300.htm#box3
Indonesia
The floating of the Thai baht in July 1997 soon intensified pressures on the Indonesian rupiah. Structural
weaknesses in Indonesia's financial sector and the large stock of short-term private sector external debt
contributed to doubts about the government's ability to defend the currency peg. After a brief period of
widening the intervention band, the rupiah was floated and, by early October, it had depreciated by 30
percent. On November 5, 1997, the authorities entered into a three year stand-by arrangement with the IMF
for US$ 10 billion, which was augmented by about US$1.4 billion in July 1998. Large amounts were also
pledged by other multilateral institutions ($8 billion) and by bilateral donors ($18 billion--the so-called
"second line of defense"). Although the rupiah initially appreciated, market sentiment began to sour again in
December 1997 - January 1998, after sixteen insolvent banks were closed by Bank Indonesia in
November. There were also slippages in program implementation coupled with serious social and political
upheaval, which culminated in the fall of President Suharto in May 1998. By end-July 1998, the rupiah had
fallen by about 65 percent relative to end-1997. The loss of confidence sparked financial instability, and
output collapsed, with a severe impact on the poor.
In August 1998, a strengthened reform agenda was reflected in a new extended arrangement with the
Fund. To break inflation, the program was anchored in firm base money control. Food security --especially
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rice--was gradually restored through emergency imports, a strengthened distribution system, and
temporary food subsidies. Banking sector reform accompanied by corporate restructuring, an effective
bankruptcy system, deregulation and privatization, and improved governance were also at the core of the
program. This policy framework delivered important results, including the virtual elimination of inflation, the
stabilization of the rupiah, and a recovery in foreign exchange reserves. Interest rates were brought down
dramatically, and rice prices stabilized. Improved market sentiment was reflected in the recovering stock
market and in falling risk premia. Nevertheless, the overall progress did not reach a decisive stage under
the program. There were lags in implementation of bank and corporate restructuring measures. Continued
weakness in the governance of key institutions was exposed in the Bank Bali scandal and, along with other
factors, led to the suspension of the IMF program in September 1999.
Against this background of fragile and incomplete accomplishments, the newly elected government
negotiated a new three-year extended arrangement for about US$ 5 billion with the IMF, which was
approved by the Fund's Executive Board in February 2000. The macroeconomic framework seeks to
restore an annual growth rate in the vicinity of 5 to 6 percent by 2002, with an annual inflation target of
below 5 percent. The Financial Sector Policy Committee was established with the mandate to provide
leadership and direction in banking and corporate restructuring. The key objective in bank restructuring
efforts is to capitalize all the banks, including through the provision of public funds, to an 8 percent capital
adequacy ratio by end-2001, as a precondition for replacing the comprehensive guarantee scheme with
self-financed deposit insurance. Other objectives include: enhancing efforts to restructure state banks,
ensuring better governance and supervision of the banking system and the Indonesia Bank Restricting
Agency (IBRA), deepening bond and equity markets, and reinforcing asset recovery efforts. The
government has developed a new strategy to give fresh momentum to corporate restructuring and to anti-
corruption measures in the judiciary.
Economic recovery is gathering pace while inflation remains subdued. GDP grew by 5.8 percent in the last
quarter of 1999 relative to the same period of the previous year, enabling a small positive growth in
calendar 1999. Consumption and de-stocking continue to be the main engines of the emerging recovery--a
pattern shared by other Asian countries emerging from the crisis. Inflation has continued to be virtually flat
since June 1999, and interest rates have been brought to pre-crisis levels.
Selected Economic Indicators
1996 1997 1998 1999 2000**
(Percent change)
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Real GDP Growth 8.2 1.9 -14.2 1.5 to 2.5 3 to 4
Consumer prices (period average) 5.7 12.9 64.7 -0.6 5.4
(Percent of GDP [minus sign signifies a deficit])
Central government balance 1.2 -1.1 -2.2 -3.3 -4.8
Current account balance -3.4 -0.9 4.4 3.1 1.9
(In billions of US dollars)
External debt 127.4 135.0 149.9 147.6 149.1
(Percent of GDP)
External debt 54.5 163.1 129.0 91.0 86.9
Sources: Indonesian authorities and IMF staff estimates.
*Fiscal year, which runs from April 1 to March 31.
**Program, budget for April 1 to December 31.
Reference: http://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/
Publications_Archive/CIB/CIB9798/98cib13
Major Issues Summary
The Asian currency crisis arose from a collapse of confidence in the ability of a number of countries to
maintain their fixed exchange rates while continuing to allow the free movement of foreign finance capital at
a time of increasing current account deficits.
The Indonesian rupiah was initially not affected by the pressure on other regional currencies. When it begin
to fall, however, the underlying weakness of the Indonesian financial sector was revealed and private
foreign debt was far higher than previously thought. The crisis worsened in Indonesia because of the lack
of an effective government policy response.
The International Monetary Fund (IMF) financial stabilisation package agreed to by the Indonesian
Government contained conditions requiring Indonesia to reform its financial sector, reduce fiscal
expenditure and radically change the nature of government involvement in the economy. Disagreements
between the Indonesian Government and the IMF over implementation of the reforms have become the
focus for controversy about the role of the IMF. Much of the controversy derives from the fact that the IMF
offered a combination of financial rescue package and economic reform program. The IMF has been
criticised for applying a formula which was inappropriate for Indonesia, was too difficult to implement in the
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time allowed and did not alleviate the immediate problems. The IMF position is that while the details of the
package can be renegotiated, such crises will recur unless Indonesia's economic institutions are reformed.
The currency crisis has combined with the effects of drought to produce rapid inflation, especially in the
cost of food and other essentials, and a great increase in unemployment and underemployment (8.7 million
and 18.4 million respectively, 30 per cent of the workforce). The return of poverty for many Indonesians and
the end to short-lived affluence for others has shattered the expectations, created by the economic
achievements of the New Order regime, that Indonesia was on the path to continued growth and prosperity.
The New Order regime based its legitimacy on a capacity to bring sustained improvements in the standard
of living of the mass of Indonesians and to meet the aspirations of an expanding middle and working class.
The apparent end to this success will have grave implications for the political stability of the Indonesian
state. The crisis has been a psychological blow to confidence that Indonesia had finally overcome its long
history of economic and political instability and was set on a long-term path to prosperity.
Indonesia has been transformed from a country with a tiny social elite and a mass of impoverished
peasants to a rapidly urbanising society with new social groups less willing to trade political rights for
personal prosperity. There is increasing resentment about the domination of economic and political life by
President Soeharto and his family and the suppression of free political expression by the Army and
Government.
There appears to be a widespread feeling within the Army that Soeharto should step down from power, but
senior officers are not yet prepared to express their feelings openly. The new Vice-President, B. J. Habibie,
is not popular with the Army and it is an open question if the Army would support Habibie becoming
President if Soeharto were to die or retire. These doubts underscore the uncertainty created by the
question of the transition from Soeharto's rule.
The crisis has raised the possibility that many ordinary Indonesian people may join in spontaneous or
organised movements of mass protest, perhaps even a 'people's power' movement like the one that
toppled President Marcos of the Philippines. Recent years have seen the growth of NGOs, labour unions
and Islamic organisations, but civil society has been stultified by thirty years of tight New Order political
control. There have been sporadic riots and the emergence of a pro-democracy student movement, but the
Army has crushed the riots and kept student protest confined to the universities. The outbreak of major riots
would put great pressure on the factionalised Army and would raise the question of whether it would move
against Soeharto.
The crisis in Indonesia has significant implications for Australia because Indonesia is now a major strategic
and economic partner for Australia. Indonesia has an important role in the Asia-Pacific region where
Australia's crucial interests lie. The Australian Government has provided emergency assistance to
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Indonesia and financially supported the IMF program as well as attempting to assist overcome
disagreements between Indonesia and the IMF.
Introduction
This year was certain to be one of some political tension in Indonesia because the country was due to go
through the five-yearly process of selecting a President. But the unexpected appearance of severe
economic problems in Indonesia has combined with the uncertainty caused by the presidential succession
to become a political and economic crisis of major proportions. Even before economic troubles developed,
there were clear signs of growing discontent with President Soeharto's Government. Popular dissatisfaction
has arisen over the suppression of democratic politics, as well as concerns, at both a popular and elite
level, about the weakness of governmental institutions under the highly personalised rule of an aging
President. A number of other Southeast Asian countries have come under great economic stress since
mid-1997, but none have experienced a crisis like Indonesia's, nor had their political problems exposed in
such a way. The events of recent months have revealed many of the problems and conflicts in Indonesian
society, politics and economy.
President Soeharto established his New Order regime after a coup in 1965 and has successfully
maintained political unity in the disparate Indonesian archipelago and presided over sustained economic
growth and development. The ageing President's unwillingness to step down from the presidency after over
thirty years in office, however, and his refusal even to countenance any serious consideration of his
eventual succession has underscored the fact of how much the stability and growth under the New Order
regime since 1965 has depended upon Soeharto as an individual.
Political power has been concentrated in a few hands, mainly in the Armed Forces of Indonesia (ABRI) and
a number of civilians related to or close to President Soeharto. Constitutional organs such as parliament
are mere rubber stamps. Similarly, the impressive economic development under the New Order has been
under the control of a small number of business organisations dependent on the direct patronage of the
President and his extended family. The lack of progress towards the development of political institutions
has been revealed by the Indonesian Government's seeming incapacity to respond to the currency crisis in
an effective manner.
This paper briefly examines the origins of the currency crisis affecting a number of countries in East and
Southeast Asia and then focuses on the crisis in the Indonesian economy and stalled efforts by the IMF to
develop a program to stabilise the Indonesian currency and reform the country's economic institutions. The
paper examines the social effects of the crisis and the impact on the well-being of ordinary Indonesians. It
discusses the political dimensions of the crisis against the background of concerns about the succession
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from President Soeharto and the growing pressure for political liberalisation, pressure which has in part
been created by the very achievements of the New Order since the 1960s. The paper concludes by
examining the implications of the Indonesian crisis for Australia and considers the prospects for a resolution
of Indonesia's current economic and political turmoil. The paper can be read in conjunction withThe Politics
of Change in Indonesia: Challenges for Australia, Parliamentary Research Service Current Issues Brief No.
3, 1996-97.
Indonesia's Economic Crisis
The background to the major problems that have emerged within Indonesia's finance and banking system
is, of course, the rapid fall in exchange rates in other Southeast Asian countries such as Thailand, South
Korea and Malaysia since mid-1997. These trends have been exacerbated by continuing sluggish growth in
Japan. These events have become well known in the Australian media under labels like the 'Asian
economic crisis' or 'Asian financial meltdown'. Such descriptions are fairly misleading, however, because
the crisis has by no means affected the whole of Asia (China, Taiwan and India have escaped serious
problems) and the effects have varied greatly throughout the region. While the majority of commentators
consider that most of the affected countries will have returned to economic health within one or two years,
there is much less optimism about Indonesia because the country's political weakness has meant that
Jakarta has not yet developed an effective policy response. The prospect of political turmoil is certain to
undermine foreign investor confidence in Indonesia, deterring the inflow of the foreign capital essential for
restoring the value of Indonesia's currency, the rupiah, and for restarting economic growth.
Origins of the Crisis
The crisis resulted from a collapse of confidence in the ability of a number of Southeast Asian countries to
maintain their fixed exchange rates while continuing to allow the free movement of foreign finance capital at
a time of increasing current account deficits.(1) The system of pegged exchange rates was one of the
fundamental features underpinning the sustained economic growth in Southeast Asia during the 1980s and
1990s because it provided certainty to investors and encouraged Japanese manufacturers to relocate to
Southeast Asia to escape competitiveness problems caused by the highly-valued yen. Difficulties began to
develop in the mid-1990s, however, when three key currencies in the region, the US dollar, the Japanese
yen and the Chinese renminbi, underwent major shifts in their relative value. In 1994 the Chinese currency
was devalued by 50 per cent against the dollar and between 1995 and 1996 the yen fell by 40 per cent
against the dollar.(2) This increased the competitiveness of Chinese and Japanese goods and made
exports from Southeast Asia more expensive since their currencies were still pegged to the rising US dollar.
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Exports from the region rapidly lost their competitiveness and ceased their previous continuous growth.
Thailand, for example, went from a 25 per cent growth in merchandise exports in 1995 to zero growth in
1996. Export growth was also affected by economic slowdown in Europe and Japan and by increasing US
textile imports from Mexico following the signing of the North America Free Trade Agreement (NAFTA).(3)
The first to show signs of crisis was Thailand where the increasing current account deficit put pressure on
Thai authorities to defend the baht by greatly increasing interest rates. This move, however, only
exacerbated problems by causing the collapse of many heavily indebted companies, particularly in the
inflated property market. This in turn worsened the problems of the financial sector which was saddled with
growing numbers of non-performing domestic loans and huge foreign debts of short-term or 'hot money'.
With foreign currency speculators expecting the Thai Government to devalue, there was a selling attack on
the baht in February 1997. The government responded by selling billions of dollars in foreign exchange
reserves to support the baht, a move which was initially successful but soon faltered in the face of an
increased attack on the currency during the year. In July 1997 the Thai Government was forced to abandon
the pegged currency and by September 1997 the baht had collapsed to 38 to the US dollar, down from the
25 to the dollar in July.(4)
The Crisis Hits Indonesia
The Indonesian rupiah was initially not affected by the pressure on other regional currencies in early 1997
because it did not appear to suffer such acute problems of a large current account deficit and high dollar-
denominated foreign debt. For several years the Indonesian central bank (Bank Indonesia) had also
allowed the rupiah to float within a range of 8 per cent, allowing a 4-5 per cent annual depreciation from
1995. When the Thai, Malaysian and Filipino currencies began to weaken in early July 1997, Bank
Indonesia took the pre-emptive measure of increasing the band within which the rupiah could float from 8
per cent to 12 per cent. By the beginning of August, however, the rupiah appeared to have caught the
'contagion' and was falling below the 12 per cent band. Bank Indonesia was forced to allow the currency to
float freely and by the end of October it had fallen from the June 1997 rate of around 2400 to the dollar to a
new low of 3600 to the dollar.(5)
The rapid fall in the rupiah, beginning in July-August 1997, soon revealed the underlying weakness of the
Indonesian financial sector. Panic selling of rupiah for dollars by Indonesian companies with dollar-
denominated debt showed that private foreign debt was far higher than previously thought. Worse still, the
fact that Bank Indonesia was unaware of the extent of the debt showed its poor capacity to oversee and
regulate Indonesia's financial markets. As in Thailand, much of the foreign debt was short-term and due for
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repayment within twelve months and, with the continuing fall in the rupiah, was increasingly difficult to
service.
The impact on many banks was rapid and calamitous. The Government liquidated 16 private domestic
banks in November. The lack of confidence in the banking sector was dramatically demonstrated later that
month when rumours of the death of the major shareholder of Indonesia's largest private bank, Bank
Central Asia, almost sparked off a run on the Bank.(6) Meanwhile the rupiah continued to fall far beyond all
predictions. By the beginning of January 1998 the Indonesian currency had tumbled to 10 000 to the dollar,
a 75 per cent devaluation since mid-1997. By the end of January the rupiah fell to its low-point of 17 000 to
the dollar and has traded in the 9 000 to 10 000 range since that time. This was also accompanied by a
deep slump in the stock market, with the index falling from 720 in July to 600 in August and falling a total of
75 per cent by mid-December.(7)
The Government's Response-Reform and the IMF
The Indonesian Government's initial response to the pressure on the rupiah was generally seen by
commentators and financial analysts as pragmatic and decisive. As well as floating the currency and
increasing interest rates, a number of policy announcements in September included plans to reorganise the
banking sector, cut some tariffs and facilitate exports, postpone or review large capital-intensive
development projects and eliminate certain restrictions on foreign equity in Indonesian companies.(8) The
short calm soon passed by, however, with a further collapse of confidence in regional currencies. This
followed comments by Malaysian Prime Minister, Mahathir, blaming the problem on international financier
George Soros. Confronted with a renewed fall in the rupiah, on 8 October 1997 the Indonesian Government
approached the International Monetary Fund (IMF) for financial support.
When approaching the IMF, President Soeharto reportedly sought only a small financial package without
conditions attached.(9) As the magnitude of Indonesia's problems became apparent, however, a much
larger agreement was negotiated with the IMF. On 31 October the IMF announced a $US23 billion rescue
package (with contributions from the World Bank and the Asian Development Bank) designed to stabilise
Indonesia's currency and restore confidence in its financial markets. It also included a number of conditions
aimed at restructuring the country's financial sector and deregulating the economy, cutting government
expenditure, reforming trade and industry policy and improving transparency in relations between business
and government.
The last condition was especially sensitive because it involved dismantling the monopolies and special
assistance provided to businesses and projects owned by the family and close associates of President
Soeharto. Such special concessions have been one of the main targets of popular resentment within
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Indonesia and, internationally, have become the symbol of the 'crony capitalism' which has undermined
confidence in the Indonesian economy.
A second IMF agreement in January 1998 set out in more detail a program designed to prevent an
economic contraction, contain inflation to 20 per cent in 1998 and move the current account from deficit into
surplus. The agreement specifically mentioned the elimination of support to the aircraft industry and the
National Car project, the restriction of the BULOG (Indonesia's food distribution agency) trade monopoly on
the import of rice, deregulation of domestic trade in all agricultural products, including cloves (a major
ingredient of Indonesian cigarettes) and the dissolution of cartels in the important cement, paper and
plywood industries. The Government also agreed to phase out energy subsidies by gradually increasing the
price of fuel and electricity, but limiting price increases for kerosene used for domestic cooking.(10)
Issues regarding implementation of the IMF rescue package have assumed centre stage of debate about
the future of the Indonesian economy. Despite President Soeharto's public commitment to implementing
the reforms in the plan, it soon became apparent that he was reluctant to accept their full implications. The
first sign was Soeharto's apparent desire to use the additional $US11 billion financial assistance offered by
Japan, Singapore, US, Malaysia and Australia in October 1997 as a less conditional source of money
which might strengthen Indonesia's hand in negotiations to soften the terms of the IMF loan. Further
indications were that Soeharto wanted to protect the monopoly of basic commodities trade held by BULOG
and to maintain funding for the heavily-subsidised state-owned aircraft industry overseen by his closest
political associate, Habibie. The day after signing the IMF package, Soeharto also signed a decree allowing
a number of the projects postponed or placed under review in September to proceed. Such signals of
unwillingness to carry out the intention of the IMF agreement caused any restoration of confidence in the
rupiah to be very short-lived and to lead to its continued downward spiral. The picture was worsened by the
public refusal by certain members of Soeharto's family to accept closure of their failed banks.(11)
The IMF formula has come under criticism, from differing points of view, that its recommendations are
inappropriate for Indonesia's economic circumstances. Some critics contended that providing emergency
loans created 'moral hazard', encouraging the governments of other developing countries to adopt
irresponsible economic policies with the assurance that the IMF would come to their rescue. Others have
criticised the conditions attached to the loans, arguing that cutting government expenditure and high
interest rates has led to an unnecessarily deep recession. The argument is that the IMF's financial
stabilisation packages tend to follow a standard formula which evolved to treat economies experiencing
hyper-inflation and bloated fiscal and current account deficits (especially in Latin America), but which was
inappropriate for Indonesia where these problems were not significant and where fiscal and
macroeconomic policy had generally been quite orthodox. There has also been criticism of IMF pressure
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for cuts to subsidies for basic consumer commodities as worsening the plight of many already
impoverished Indonesians.
Much of the reason for controversy surrounding the IMF program derives from its character as a
combination of financial rescue package and economic reform program. The IMF has been criticised for
using loans designed for immediate stabilisation to force Indonesia to adopt major policy reforms, the scope
of which would be difficult for even a developed country such as Australia to introduce in such a short time.
A number of commentators have argued that an international financial institution has no place enforcing a
program which appears to be aimed at applying pressure for political change within Indonesia and which, it
is argued, infringes Indonesia's sovereignty. From the point of view of the IMF, however, there is little point
providing emergency finance to stabilise the Indonesian currency if the structural problems seen to be
behind the crisis are not ameliorated. The Fund also considers that confidence in the Indonesian currency
will not be restored unless international investors are reassured that the Indonesian Government is
prepared to take measures which confront the structural problems in the economy, despite the political and
social pain they may cause.(12)
With the Indonesian Government showing itself to be increasingly uncomfortable with the IMF reform
program, some observers have seen the situation in Jakarta since late last year as one of virtual policy
paralysis. While the Indonesian Government has been inconsistent in its commitment to implementing
reform, it has done little to develop alternative policies, even for the short term. A proposal to introduce a
Currency Board system, under which each rupiah would be backed by US dollar reserves, was widely
criticised as unworkable and aimed at securing the assets of powerful business interests rather than in
solving the country's currency problems. Moreover, the indecisive debate over the proposal occupied
several months of precious time, during which Indonesia's economic difficulties have become increasingly
urgent. The Government's incapacity to come to terms with the depth of the problems it faces was also
seen to be exemplified in the Budget delivered in late 1997 which contained completely unrealistic
estimates of the coming year's economic growth and fiscal balance and which had to be revised drastically
downwards in a new Budget announced on 23 January 1998.
The IMF delivered the first tranche of $US3 billion in November 1997 and the second of $US3 billion was
due on 15 March 1998. In the face of the Indonesian Government's apparent unwillingness to proceed with
the agreed reforms at the specified pace, however, the IMF postponed delivery of the money. This move
was triggered by the actions of the Indonesian Government in restructuring a number of monopolies in such
a way as to preserve the influence of key individuals and in its slowness in preceding with other agreed
reforms. Recent reports suggest that the IMF and the Indonesian Government are moving towards
developing a new agreement. Any decision to further postpone or even withdraw financial assistance to
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Indonesia would have a disastrous effect on the Indonesian currency, with the certainty of a renewed
collapse in its exchange value.
The IMF has been confronted with a dilemma. To continue further tranches of assistance without
substantial moves by the Indonesian Government would make a mockery of its efforts to achieve long-term
reform, but to withhold assistance and allow the collapse of the rupiah would damage the Indonesian
economy and worsen political unrest. It would also adversely affect the economic health of the entire
region. Current Indonesian Government economic projections for 1998 are for zero economic growth and
inflation of 20 per cent. Many economists have already concluded that these figures are overly optimistic,
with estimates of growth (or contraction) ranging from minus 3 per cent to minus 10 per cent and an
inflation rate of up to 100 per cent. Interest rates are now running at between 30 and 40 per cent. At the
current exchange rate of around 10 000 rupiah to the dollar, virtually every company listed on the
Indonesian stock exchange is technically bankrupt. Only if the exchange recovered to around 5000 to the
dollar would they be able to service their foreign debt and maintain profitable overseas trade. A continued
standoff between the IMF and the Indonesian Government would have very serious implications indeed.
Social Effects of the Crisis
The most immediate and widespread effect of the economic crisis on the people of Indonesia has been
accelerating inflation. During the first half of 1997, Indonesia was experiencing particularly low inflation (2.6
per cent), but the price increases of the second half brought annual inflation for 1997 to 11 per cent,
compared with a rate of 6.5 per cent in 1996. Since the beginning of 1998, price increases have
accelerated still further to levels which threaten hyper-inflation. Inflation for January and February 1998 was
20 per cent and estimates for annual inflation for the coming year have ranged from 40-50 per cent up to
100 or even 200 per cent.(13) Prices have risen across most sectors, but the most severe increases have
been in critical areas such as food and other essentials. Food prices increased by 30 per cent during
January and February. During the last year, rice has increased from 1800 rupiah per kilo to 3500 ($A0.36 to
$A0.70 at April 1998 exchange rates) and cooking oil from 2000 rupiah per litre to 5500 ($A0.40 to $A1.10).
The price of protein sources such as eggs, soy beans and chicken are rising beyond the reach of many
low-income consumers.(14)
The most serious aspect of the food situation is that the problems caused by the falling rupiah are occurring
at the same time as Indonesia is suffering its worst drought for many years. Rice production has already
fallen by 10 per cent in the last year due to the effects of El-Nio and there is a strong possibility that the
drought will continue into this year. Indonesia's food distribution agency, BULOG, will be forced to continue
and increase its import of food staples to keep prices down and maintain food distribution. BULOG has
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been allowed to purchase foreign exchange at a subsidised rate of 5000 rupiah to the dollar, the effect of
which is that food imports are being subsidised by the Central Bank at the cost of the country's already
weak foreign exchange position. If currency and drought problems persist into the coming months,
sustaining food imports will become an increasingly difficult task.
There are also doubts about the effectiveness of the distribution system in many areas, particularly in poor
and remote eastern regions of the country which have been particularly affected by the drought. Shortages
have been made worse in some districts by hoarding and panic buying. Nevertheless, the food situation in
Indonesia has not reached anything approaching disaster proportions. Immediate stocks are sufficient and
BULOG has generally proved to be effective as a food import and distribution agency in the past. Concern
will mount in the second half of 1998, however, especially if the rains are poor.
Job Losses, Unemployment and Underemployment
The collapse of Indonesia's currency and the consequent exposure of the private sector to massive
unrepayable foreign debt has had a devastating impact on employment, especially in urban areas.
Accurate figures on the extent of job losses are impossible to obtain, but most estimates put the figure at
around two million.(15) The industry which felt the most immediate effect was construction (where an
estimated one million workers have been laid off) because much short-term foreign borrowing had been
directed into city building and infrastructure projects. There have also been extensive lay-offs in
manufacturing and in the banking and service sector as new highly-leveraged manufacturing concerns
have gone bankrupt. The banking sector has virtually collapsed and industries providing services to new
industries and consumers have lost their customers. Indonesia had experienced strong employment growth
for the past several years, but it is the jobs in the new growth areas which have been most vulnerable to
changed economic circumstances.
It is often assumed that wage-workers in developing countries can return to their villages if they lose their
city jobs and, indeed, this was often the case in the past when the wage sector of the workforce was very
small. But the transformation of the Indonesian economy in the last two decades has meant that rural areas
can no longer function as a 'shock-absorber' for unemployment. This is particularly true of the most
populous island of Java where the majority of the workforce is now employed in secondary industry and
services, with a minority still employed in agriculture. With the introduction of new farming techniques and
technology, agricultural productivity has greatly increased, but modernised agriculture frequently employs
fewer people than traditional methods. In any case, productivity increases have plateaued in recent years
and there are already large numbers of underemployed people (working only a few hours a day or a few
months each year) in rural areas. At the best of times there are no prospects for a worker returning to the
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village, in today's drought there is nothing to offer but hunger. Most unemployed urban workers are forced
to eke out an existence in the informal sector (street hawking etc.), depend on family support or seek work
in regional towns. The lack of a state system for social support means that official statistics greatly
underestimate the problem, but even these calculate unemployment and underemployment to have
doubled in recent months to 8.7 million and 18.4 million respectively, figures which represent more than 30
per cent of the workforce.(16)
An End to Affluence, a Return to Poverty
Most industrial workers worked for low wages in poor conditions, but in most cases city jobs represented an
improved standard of living over rural semi-employment, especially with the steady increase in wage levels
over recent years. Today, however, job losses, falling wages and the spiralling cost of essential
commodities have thrown many urban workers back into a struggle for basic existence. For the millions of
people drawn into employment in the modern sector of the economy in recent years, the crisis has cut short
the promise of being freed from the poverty which had ruled their families' lives for generations.
In rural areas, drought, rice shortages and price increases are also bringing a return to serious and
widespread poverty. World Bank estimates suggest that the number of those below the poverty line will
increase from 23 million to 40 million.(17) The breakdown of services such as public transport (due to fuel
price increases and shortage of imported spare parts) have affected urban and rural areas alike. For the
middle class and salaried employees, the crisis has meant a sudden end to the relative affluence which
they had begun to accept as normal. Many small business people have been bankrupted or confronted with
a drastic decline in business and salaried employees have either lost employment or have had their often
fixed salaries eroded by inflation. These groups were also the greatest consumers of imported goods and
services and of public goods such as transport, electricity, education and health services, all of which have
become much more expensive in the wake of the crisis.
The effects of the economic crisis in Indonesia have clearly been felt differently by different sections of
Indonesian society. But the common impact of the crisis has been the shattering of what appeared to most
Indonesians to be the promise of improving prosperity. Notwithstanding a number of setbacks in the 1970s
and 1980s, stemming mainly from problems in the important oil industry, Indonesia experienced sustained
economic growth under the New Order, with an average of about 7 per cent annual growth in the last
decade. This growth created unprecedented opportunities for large numbers of Indonesians, with the
prospect of continued improvement. The economic crisis, with its inflation, food shortages, widespread
bankruptcies and loss of jobs, has threatened to end the recently-acquired affluence of some Indonesians
or to bring a return to poverty for many more. The crisis has been a psychological blow to confidence that
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Indonesia had finally overcome its long history of economic and political instability and was set on a long-
term path to prosperity.