Focus on Trade #23, part 3 of 8 (fwd)

[Robert Weissman <rob@essential.org>]

FOCUS-ON-TRADE #23, MARCH 1998
SPECIAL ISSUE ON THE IMF

Part 3 of 8

A regular bulletin produced by Focus on the Global South, Bangkok,
Thailand

Focus-on-Trade is a regular electronic bulletin providing updates and
analysis on regional and global trade and finance.  Although initially
concerned with APEC, the scope of the bulletin now extends to include
the World Trade Organisation (WTO), the International Monetary Fund
(IMF), the ASEAN Free Trade Area (AFTA), the Multilateral Agreement on
Investment (MAI) and any other acronyms that require critical
attention. Focus-on-Trade contains updates on trends in world trade,
with an emphasis on analysis of these trends from an integrative,
interdisciplinary viewpoint that is sensitive not only to economic
issues, but also to ecological, political, gender and social issues.
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IN THIS ISSUES

Taming the Tigers: The IMF and the Asian Crisis

by Nicola Bullard, with Walden Bello and Kamal Malhotra

This paper is published jointly by Focus on the Global South in
Bangkok and CAFOD in London for the Asia Europe Meeting (ASEM)being
held in London on 2 and 3 April 1998. The paper will be officially
released on 2 April in London by the two organisations. If you would
like a hard copy, please contact Focus on the Global South at
admin@focusweb.org or CAFOD at dgreen@cafod.org.uk.


The paper is in EIGHT parts:

Part 1: Executive Summary, Introduction and WHOLE DOCUMENT AS 
ATTACHMENT

Part 2: The IMF and Thailand
Part 3: The IMF and Indonesia
Part 4: The IMF and South Korea
Part 5. The social impact of the crisis
Part 6. The social impact of the crisis/The role of the IMF
Part 7: The role of the IMF
Part 8: Conclusions and recommendations, footnotes

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Part 3 of 8

THE IMF AND INDONESIA

Under the volcano
In September 1997, the World Bank was still saying, "Indonesia has achieved
a remarkable economic development success over the past decade and is
considered to be among the best performing East Asian economies."
Astonishingly, this view was still on the Bank’s public website as late as
March 1998.  
The report continues:
"Indonesia has made great strides in diversifying its economy and promoting
a competitive private sector through sound macro-economic management,
increased deregulation and deeper investment in infrastructure services.
Today both foreign and domestic investment are booming…  Indonesia’s
investment rates have steadily increased and are now among the highest in
the large developing countries.  Much of the dynamism can be traced to the
government’s reform programme which liberalised trade and finance and
encouraged foreign investment and deregulation". 
This is the same country that has, in the past six months, seen its stock
market drop by 50 per cent, whose currency has plunged more than 70 per cent
and whose "dynamic economy" is being subjected to an amazingly detailed and
interventionist set of IMF conditions linked to a $43 billion bailout loan.

In July 1997, shortly after the Thai baht was unpegged from the US dollar,
investors and currency speculators, who were either nervous or
opportunistic, started to test the "fundamentals" in other Asian countries
by selling off stocks, calling in debts and dumping currencies, thus
triggering the "contagion" effect which caused currencies and economies
throughout the region to collapse. Malaysia, Indonesia and the Philippines
were most severely affected, as relentless attacks on their currencies
forced each, in turn, to abandon the fixed exchange rate and let the market
determine the currency’s value.  
The weaknesses in the Indonesian economy that made it vulnerable to currency
attacks were similar to Thailand’s: rising external liabilities, private
sector debt problems and poor loan quality, lack of confidence in the
government’s ability to resolve the problems, excessive amounts of foreign
investment inflating an expanding asset bubble and an overvalued currency
pegged to the strengthening US dollar. Although most of the macro-economic
indicators were deemed sound, the financial sector was deeply suspect and
proved to be the weakest link in the chain.  
Early in the crisis the Indonesian government attempted to calm the
situation by defending the currency, using Central Bank reserves, and
loosening its control on the exchange rate. However by 13 August, just as
Thailand was signing a deal with the IMF, the rupiah hit a then historic low
of 2,682 to the dollar, from a pre-July level of 2,400. On 14 August the
government abolished the managed exchange rate and the rupiah slid
immediately to 2,755. 
Even though the Central Bank attempted to defend the currency by raising
interest rates and the Government announced that projects worth 39 trillion
rupiah would be postponed to meet the budget shortfall, the situation
continued to deteriorate and by 6 October the rupiah was at a new low of
3,845 to the dollar. 
Two days later, faced with declining reserves, collapsing financial
institutions, and capital haemorrhaging from the country, the Government
announced its intention to seek IMF assistance.  By 31 October, Indonesia
had agreed to a $43 billion  loan agreement. Of this, $23 billion was ‘first
line financing’ made up of $10 billion from the IMF, $4.5 billion from the
World Bank, $3.5 billion from the Asian Development Bank and $5 billion from
Indonesia’s own international reserves. Second line supplementary financing,
totalling about $20 billion, included $6 billion from the US, $5 billion
each from Japan and Singapore and $1 billion each from Australia and Malaysia.  
The agreement represent about 490 per cent of Indonesia’s Special Drawing
Rights, just below the 500 per cent threshold requiring special approval. 
The objectives of the package were to "stabilise exchange market conditions,
ensure an orderly adjustment of the external current account in response to
lower capital inflows, and lay the groundwork for a resumption of sustained
rapid growth."  
The targets set for Indonesia included a current account deficit of 2 per
cent of GDP, official reserves worth about 5 months of imports and a budget
surplus of 1 per cent achieved by increasing revenue through excise taxes
and removing tax exemptions. 
The main policy measures to achieve these objectives were tight monetary
policy (pushing up interest rates to mop up excess money, to reduce the debt
component of financing in favour of equity and to attract foreign
investment), closing unviable banks, liberalising foreign trade and
investment, dismantling domestic monopolies and expanding the privatisation
programme. 
Specific reforms included reducing tariffs in sectors such as chemicals,
fisheries and steel products, an explicit agreement to implement ahead of
schedule the WTO ruling on the National Car (a case brought by the US)
should the ruling go against Indonesia, and postponing or rescheduling major
state investments. The Suharto government also agreed to reduce export
taxes, open more sectors of the economy to foreign investment and privatise
public enterprises under the management of a newly established privatisation
board. 
IMF causes bank run
Rather than restoring confidence, however,  the IMF directive to close down
sixteen insolvent banks caused panic, precipitating a run on two thirds of
the country’s banks, further weakening the financial sector and eroding
faith in the economy. The Fund itself admitted as much in an internal memo
which was reported in the New York Times in mid-January:
"A confidential report by the International Monetary Fund on Indonesia’s
economic crisis acknowledges that an important element of the IMF’s rescue
strategy backfired, causing a bank panic that helped set off financial
market declines in much of Asia…These closures, far from improving public
confidence in the banking system, have instead set off a renewed ‘flight to
safety’. Over two thirds of the country’s banks were affected, and more than
$2 billion was withdrawn from the banking system".  
For the next two months, the IMF bailout did little to staunch the flow of
money out of the country or slow the plunging rupiah. Clearly the market
needed more that the IMF’s intervention to convince it that all was well in
the State of Suharto. Neither the IMF nor the investors had confidence in
the determination of the Indonesian Government to stick to the loan
conditions, and confusion resulting from contradictory messages coming from
Jakarta exacerbated the situation. 
At one moment, the 76 year old President was promising to axe a slew of
major infrastructure projects, the next he earmarked a select fifteen for
preferential treatment and continued support. The fact that several of these
projects directly involved or benefited his immediate family highlighted the
extent to which the Indonesian economy and its institutions are embedded in
a nepotistic system of money-lending and deal-making limited to an inner
circle of Suharto’s offspring and friends. 
Estimates of the family fortune vary wildly, from $6 to $40 billion, making
it one of the world’s largest family fortunes and "Suharto’s six children
have used political influence to amass holdings that range from airlines,
banking and petrochemicals to the Timor, Indonesia’s national car. Foreign
companies hoping to do business in Indonesia often hire Suharto scions as
‘consultants’ to grease the wheels."   
The inside story of the 17 January issue of The Economist (with the cover
banner ‘Step down, Suharto’) commented that:
"Mr Suharto has proved better at promising reform that delivering it. He is,
after all, being asked to dismantle an economic structure which has created
enormous fortunes for his sons and daughters… As his relations squeal, he
may backslide, setting off a new onslaught on the currency, new bouts of
panic hoarding, new hyperinflationary pressures".  
The crisis in Indonesia started to quicken in early December when rumours of
Suharto’s ill-health and his non-attendance at the ASEAN meeting in Kuala
Lumpur triggered concerns about political and social stability. For anyone
who has taken more than a passing interest in Indonesian affairs, the
unsustainability of Suharto’s regime and the political vacuum he has created
is no surprise. Yet it seems that as long as the aging autocrat continued to
deliver the economic goods, no-one was too concerned.  
However, as the economy started to collapse it became obvious that the
rhetoric of national unity and growing prosperity was cloaking a darker
reality of dissent, despair, anger and poverty, likely to be translated into
violence and chaos.  The Economist put it succinctly, saying that "what
looked like political stability during a bull market looks like dangerous
rigidity when times are tough."  
Suharto defies the IMF 
President Suharto’s budget speech of 6 January had a devastating effect. He
announced substantial increases in the subsidies for petrol and staples such
as rice and fertiliser and an overall 32 per cent increase in government
spending, but gave no hint of when and how subsidies and monopolies would be
abolished. 
In addition, the budget figures were based on extremely optimistic
assumptions such as 4 per cent growth, 9 per cent inflation and an exchange
rate of R4,000 to the dollar. (At the time of writing the growth estimate is
-0.5 per cent, annualised consumer price inflation for February 1998 was 32
per cent, and the rupiah is still hovering around 10,000 to the dollar with
no improvement in sight). 
Faced with massive unemployment, a rapidly contracting economy and potential
social unrest, Suharto’s budget could be seen as a logical response to the
circumstances. However, both the IMF and the markets disagreed. The market
responded by further selling off the currency and by moving more money
offshore, sending the rupiah through the critical psychological 10,000 mark
on 9 January.  

By then the political and economic situation was spinning out of control
with food prices soaring and reports of rioting and food hoarding. The
government’s response was to announce jail sentences for hoarding and to put
the army in charge of food distribution – hardly the sort of measures to
calm a jittery population and the even more nervous investors.
US turns up the heat
The IMF responded by flying in top-level officials to strong-arm Suharto
into reneging on his budget promises and to reaffirm his commitment to the
IMF deal.  Suharto also received phone calls from US President Clinton,
Japan’s Prime Minister Hashimoto, Australia’s John Howard and Helmut Kohl of
Germany, all urging him to revise the budget and stick to the IMF
conditions. Clinton dispatched two senior members of the administration,
Secretary for Defence William Cohen and Deputy Secretary to the Treasury
Lawrence Summers to "deliver messages" to President Suharto.
Using tremendous pressure, the IMF was able to extract a new commitment from
Suharto on 15 January 1998, powerfully captured in the photograph of IMF
Managing Director Michel Camdessus, arms crossed with the demeanour of an
invigilator, imperiously standing over Suharto as he signed on the dotted
line. But the markets were not calmed and stocks fell a further 4 per cent.
>From a steady 2,400 in July, the rupiah took five months to slide to 4,000
in early December, and thereafter just one month to crash to an astonishing
17,000 to the dollar by 22 January. 
The details of the second IMF agreement were published in detail, no doubt
to put further pressure on Indonesia and to convince the markets that their
concerns were being addressed. 
The agreement acknowledges that "The enormous depreciation of the rupiah did
not seem to stem from macroeconomic imbalances, which remained quite modest.
Instead, the large depreciation reflected a severe loss of confidence in the
currency, the financial sector and the overall economy."   
In contrast to the first agreement which set quite specific macro-economic
targets, the second realistically asserts that: "Under current volatile
conditions it is difficult to set precise macroeconomic targets.
Nevertheless, the programme is designed to avoid a decline in output, while
limiting inflation to about 20 per cent". 

The specific macro economic objectives are:
-      to achieve a current account surplus, 
keep inflation to 20 per cent, set a balanced budget (a change from the
earlier requirement of a budget surplus), 
eliminate subsidies on electricity and fuel (except kerosene and diesel)
commencing on 1 April, 
increase excise on various goods, end all VAT exemptions, 
impose a 5 per cent tax on gasoline, improve tax recovery, 
include the investment and reafforestation funds in central revenues from
fiscal year 1998/99, and ensure that the reafforestation fund is used
explicitly for the specified purposes.  
Specific steps to liberalise trade and investment included:
- 	reducing tariffs on all imported foodstuffs products to 5 per cent and
cutting non-agricultural tariffs to 10 per cent by 2003,
a major overhaul of the banking system, including opening banks to foreign
ownership by June 1998, 
lifting restrictions on foreign banks by February 1998, 
the establishment of the Indonesian Bank Restructuring Agency to dispose of
the collateral backing problem loans and oversee the merger or liquidation
of weak financial institutions. 
But even here there is "considerable scepticism… about the ability of the
new agency to close down weak financial institutions with strong political
connections, particularly those with ties to Mr Suharto’s extended family."  
Suharto’s ‘family values’ under attack
What the new deal lacks in macro-economic targets is made up for in
micro-economic directives which strike at the very heart of Suharto’s
economic power, addressing in minute detail the dismantling of cartels,
monopolies and taxes which directly benefit Suharto, his family and friends. 
Twelve megaprojects were cancelled, including several directly linked to
Suharto’s sons and daughters and all special benefits for the National Car
project (run by Suharto’s youngest son Tommy) and the aircraft project (run
by Suharto’s "golden boy" and newly appointed vice-president B.J. Habibie)
were stopped.   
The Fund also demanded liberalisation of trade in agricultural products such
as cashews, cloves, oranges and vanilla, removing restrictions on foreign
investment in the palm oil industry by 1 February and on wholesale/ retail
trade by March 1998 and closing the Clove Marketing Board (run by Suharto’s
son Tommy) by June 1998. 
Even on this seemingly minor condition, there has been no positive
Government action. In late February a cabinet minister made comments
"suggesting that the clove marketing board may be continued, on a different
basis."  The clove business is extremely lucrative in Indonesia, since
powdered cloves are an essential ingredient of the local cigarettes. 
The Fund also demanded the break-up of formal and informal cartels,
monopolies and marketing arrangements (such as those in plywood, paper and
cement) whereby producers are required to sell through a central marketing
agent, pay commissions, or be allocated production quotas or market shares. 
It also restricted the monopoly of the state logistics body, Bulog, to rice.
Flour had been included in the first agreement but was subsequently dropped,
reportedly threatening the ability of Suharto’s friend Liem Sioe Liong (the
world’s biggest manufacturer of instant noodles) to control the price of
wheat. Sugar imports will be deregulated and farmers will not be forced to
plant sugar cane, allowing land currently used for sugar to be turned over
to rice.
Social spending will be increased to provide nine years’ education and
better basic medical services.
Following the new agreement with the IMF, the Indonesian Government
announced on 27 January a temporary freeze on corporate debt servicing by
Indonesian companies, along with plans for a new government agency to
oversee bank reforms, including closing down non-viable banks and selling
assets. 
The financial sector in Indonesia is in dire straits. Capital flight,
rumoured to have begun as early as March 1997 when violent rioting and
looting against the minority ethnic Chinese, has caused many to send their
money off-shore to safer havens in Singapore and Hong Kong. 
The capital flight has been so dramatic that Indonesia’s very solvency is
threatened, with foreign banks severing inter-bank ties to Indonesian banks
and refusing to accept letters of credit, preventing importers from bringing
in raw materials and other inputs from abroad. In addition, the collapsing
rupiah means that the price of imported goods has more than doubled,
supplies are dwindling, people are hoarding, hospitals are having to cut
back and even basic medical supplies are now out of reach. 
The IMF conditions gave momentum to the already rising food prices by ending
subsidies on staples such as beans, sugar and flour. Prices are expected to
rise again after 1 April when state subsidies on fuel and electricity are
due to be lifted. 
Meanwhile, the Indonesian economy is burdened with a huge foreign debt,
estimated at the end of December 1997 at $140 billion (two thirds of GDP) of
which $20 billion was short term, and $65 billion owed by private
non-financial institutions.  This translates into a debt service ratio of
about one third of exports of goods and services. 
Currency Board fools no-one, except investors
In a desperate effort to attract foreign currency President Suharto
announced in mid-February plans to establish a currency board. The basic
principal of a currency board is that every unit of local currency in
circulation is backed by foreign reserves at a fixed exchange rate (5,000 -
5,500 was mooted as the rate for the rupiah). This put him on a collision
course with the IMF, which threatened to withdraw the $43 billion credit
should Jakarta pursue the idea. 
Suharto, in a grim effort to retain control over economic policy, held on to
the last, even dismissing the Central Bank Governor who apparently did not
support the idea of a currency board. The debate over the currency board is
likely to continue. As recently as 11 March, Jakarta was buzzing with
rumours that the Board would be set up within two days. "The government is
looking for a quick fix and it seems probable that the solution is the
currency board," said an Indonesian analyst at Goldman Sachs in Singapore. 
There are several explanations for Suharto’s interest in the currency board.
Firstly, even if the board was in place for just one or two days, it would
allow the Suharto circle to wipe off their foreign debts at R5,500 rather
than R10,000. 
Secondly, it gave Suharto some breathing space to reassert his control over
economic policy after the humiliating acquiescence to the IMF earlier in the
year. Whatever his motivation, talk of the currency board has had the effect
of sucking foreign exchange into the country from investors eager to get in
early just in case the rupiah is re-pegged at a lower rate.
Unlike Thailand and South Korea, Indonesia has been a reluctant, even
belligerent, recipient of the IMF’s largesse. Clearly, Suharto has vested
interests to protect, the very same interests which are being singled out by
the IMF in their bid to restore confidence in the Indonesian economy. 
In the invidious struggle for power between the Fund and the President, no
holds are barred. In early March US President Clinton sent former
vice-president Walter Mondale to have a heart-to-heart talk with Suharto,
while Suharto continues to antagonise the West by pushing the currency board
plan, brazenly assuming the mantle of President for a seventh consecutive
term and even nominating the profligate spender B.J. Habibie as
vice-president. In the midst of all this arrogance and intransigence, 200
million Indonesians are suffering. 
The impact has been devastating. Estimates of the total number of people who
had lost their jobs by the end of 1997 varied enormously, from 2.5 million
to 6.6 million. The construction industry in particular has ground to a halt
with at least 950,000 workers losing their jobs. Unemployment has jumped
from 7.7 per cent to 10 per cent and is expected to climb further during 1998.
By late March, the currency devaluation and capital flight had left the
financial sector in ruins, causing prices to rise and businesses to crash.
Because the Government had dragged its feet on implementing the IMF reforms,
it was impossible to assess what impact they would have on the present
situation, or indeed on the long term economic and political future of
Indonesia. In any case, political concerns had overtaken the economic
crisis, and one could not be resolved without the other.

END PART 3 OF 8


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Focus on the Global South (FOCUS)
c/o CUSRI, Chulalongkorn University	
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Staff email addresses:
----------------------
Walden Bello                W.Bello@focusweb.org
Kamal Malhotra              K.Malhotra@focusweb.org
Chanida Chanyapate Bamford  C.Bamford@focusweb.org
Junya Prompiam              J.Prompiam@focusweb.org
Nicola Bullard              N.Bullard@focusweb.org
Ehito Kimura                E.Kimura@focusweb.org
Joy Obando                  Joy@focusweb.org
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Focus Administration        admin@focusweb.org 
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