The IMF and the Indonesian crisis

Abstract

Given the strong performance and resilience of the Indonesian economy over the previous three decades, the depth and duration of the 1997–98 crisis was unexpected. The IMF's initial policy prescription was in keeping with the nature of the crisis—characterised by a reversal of foreign capital inflows, interacting with a weak domestic financial sector. But this prescription would work only if there was a quick restoration of market confidence. This was not achieved, and indeed public disputation over the elements of policy undermined confidence. Additional policy elements were needed that would address the capital outflows more directly and resolve the banking collapse. There was a loss of policy cohesion between the Fund and the Indonesian authorities, and among the authorities themselves. Before alternative policies could be put in place, the political dimension became paramount.

Notes

¹Without attempting a comprehensive enumeration, the following would be among the core sources. Blustein (2001); Goldstein (1998); Hill (1999); IMF IEO (2003); Fischer (2001); Frécaut (2002); Kenward (2002); McLeod (1998); and Nasution (2002). More specific to the financial aspects are Cole and Slade (1998); Enoch et al. (2003); and Pangestu and Habir (2002).

²On interest rates, see Furhman and Stiglitz (1998); on structural conditionality, see Feldstein (1998). For an overall assessment of these issues, see IMF IEO (2003).

³These ‘second line of defence’ funds were similar to the Thai bilateral assistance funds, but were to be used only after the IMF funds were fully committed.

⁴McLeod (1998: 40–1) paints a rather different picture of this episode, arguing that ‘there was simply no coherent strategy for using these funds’.

⁵The norms of assistance were changing rapidly at the time. South Korea was to receive over 1,900% of quota a few months later. (Each IMF member country is assigned a quota based broadly on relative economic size; this ‘determines its maximum financial commitment to the IMF and its voting power, and has a bearing on its access to IMF financing’; http://www.imf.org/external/np/exr/facts/quotas.htm.) Both Brazil and Turkey have current programs in the order of $30 billion, and Uruguay received a program equal to 20% of GDP.

⁶On contagion from Thailand, see McLeod (1998).

⁷Some have suggested that the size of the foreign borrowing was not known to markets. While the full extent of the borrowing was not known with precision, its broad scale and short-term nature were (see, for example, Radelet 1995).

⁸It is now said by the Fund that Japanese banks agreed to remain in place in Thailand (Boorman et al. 2000), but the chair of the Thai assistance meeting (an IMF deputy managing director) in August 1997 specifically prevented any discussion of this topic, and outflows equal to 12% of GDP in 1998 do not suggest that any behind-the-scenes deal was effective.

⁹The G10 group comprises 11 industrialised nations: Belgium, Britain, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland and the US. It forms a long-established ‘inner club’ within the IMF, with its own schedule of meetings at which common viewpoints and bargaining positions are reached.

¹⁰In practice the more important factor might have been the wish to use the opportunity of the crisis to push through long desired reforms (IMF IEO 2003: 42; Djiwandono 2001a: 5).

¹¹For discussion of the closures, see McLeod (1998) and Cole and Slade (1998). On the merits of a bank guarantee, see IMF IEO (2003: 40, 76) and Enoch et al. (2003: 84–6). It is worth noting that bank closures were not made in the early stages of the crises in Thailand and South Korea, and when they were, it was only with full deposit guarantees in place.

¹²Fischer's explanation of this event (Fischer 2001: footnote 24) is disingenuous: it might (incorrectly) give the impression that public statements by Fund officials had not contributed to this very damaging episode.

¹³For a discussion of conditionality, see McLeod (1998).

¹⁴This was the trigger for the downfall of Soeharto, and has proven just as difficult in the post-Soeharto era.

¹⁵What Freudian process was guiding the Fund's managing director as he was photographed standing, arms folded like a teacher with a recalcitrant pupil, while the president of Indonesia signed the LOI in January 1998?

¹⁶The ‘crony cabinet’ appointed in March 1998, remarkably and unexpectedly, managed to jump many of these hurdles, but even where there was success—for example in the elimination of the much derided clove market monopoly—the political capital used up in these victories was not available for the central issues, such as bank restructuring.

¹⁷Former US Federal Reserve chairman Paul Volcker captured the nature of the problem during a visit to Indonesia early in January 1998, when he described the policies as more a ‘cooking program’ than an economic one.

¹⁸For the debate within the Fund, see IMF IEO (2003: 68).

¹⁹Indonesia had floated briefly in the 1960s, under very different circumstances.

²⁰Fischer (2001: 25) blames domestic outflows for much of the problem, but does not provide any evidence.

²¹For some discussion of this period, see Cole and Slade (1998) and Fane (1998).

²²Another possibility worth considering might have been to introduce a dual exchange rate, making foreign exchange available at a realistically fixed exchange rate for imports of goods and non-debt services. Other foreign exchange needs would have had to be met in the open market. While there would have been a lot of leakage from any such dual rate system, it would have reinforced inhibitions on capital transactions and further encouraged foreign creditors to strike a deal.

²³The level of outstanding credit continued to rise quickly in part because accrued interest was capitalised.

²⁴For a debate on this issue, see Grenville (2000a, 2000b) and Fane (2000).

²⁵Three BI managing directors were dismissed on the president's orders at the end of 1997, and the BI governor in February 1998. As well, the head of the economic team was out of action because of ill health for some of the critical period.

²⁶One widely accepted policy making adage is: ‘You can’t beat something with nothing’. When alternatives such as the highly inappropriate currency board proposal came up in early 1998 (McLeod 2000: 23), there was no policy alternative offered other than ‘more of the same’.

²⁷For a description of these discussions (particularly the role of the US executive director) see Blustein (2001: 101, 114 and 156).

²⁸IMF IEO (2003: 72) suggests that the Fund did not know about this until early in 1998.