economics (indonesia)

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Reference: https://en.wikipedia.org/wiki/1997_Asian_financial_crisis#Indones ia 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

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Economic in Indonesia

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Page 1: Economics (Indonesia)

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

Page 2: Economics (Indonesia)

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,

Page 3: Economics (Indonesia)

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

Page 4: Economics (Indonesia)

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)

Page 5: Economics (Indonesia)

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

Page 6: Economics (Indonesia)

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

Page 7: Economics (Indonesia)

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

Page 8: Economics (Indonesia)

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.

Page 9: Economics (Indonesia)

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

Page 10: Economics (Indonesia)

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

Page 11: Economics (Indonesia)

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

Page 12: Economics (Indonesia)

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.