Declaration of ASEAN Concord Indonesia, 24 February 1976

Declaration of ASEAN Concord
Indonesia, 24 February 1976

________________________________________

The President of the Republic of Indonesia, the Prime Minister of Malaysia, the President of the Republic of the Philippines, the Prime Minister of the Republic of Singapore and the Prime Minister of the Kingdom of Thailand :

REAFFIRM their commitment to the Declarations of Bandung, Bangkok and Kuala Lumpur, and the Charter of the United Nations;
ENDEAVOUR to promote peace, progress, prosperity and the welfare of the peoples of member states;

UNDERTAKE to consolidate the achievements of ASEAN and expand ASEAN cooperation in the economic, social, cultural and political fields;


DO HEREBY DECLARE:
________________________________________
ASEAN cooperation shall take into account, among others, the following objectives and principles in the pursuit of political stability :
1. The stability of each member state and of the ASEAN region is an essential contribution to international peace and security. Each member state resolves to eliminate threats posed by subversion to its stability, thus strengthening national and ASEAN resilience.

2. Member states, individually and collectively, shall take active steps for the early establishment of the Zone of Peace, Freedom and Neutrality.

3. The elimination of poverty, hunger, disease and illiteracy is a primary concern of member states. They shall therefore intensify cooperation in economic and social development, with particular emphasis on the promotion of social justice and on the improvement of the living standards of their peoples.

4. Natural disasters and other major calamities can retard the pace of development of member states. They shall extend, within their capabilities, assistance for relief of member states in distress.

5. Member states shall take cooperative action in their national and regional development programmes, utilizing as far as possible the resources available in the ASEAN region to broaden the complementarity of their respective economies.

6. Member states, in the spirit of ASEAN solidarity, shall rely exclusively on peaceful processes in the settlement of intra-regional differences.

7. Member states shall strive, individually and collectively, to create conditions conducive to the promotion of peaceful cooperation among the nations of Southeast Asia on the basis of mutual respect and mutual benefit.

8. Member states shall vigorously develop an awareness of regional identity and exert all efforts to create a strong ASEAN community, respected by all and respecting all nations on the basis of mutually advantageous relationships, and in accordance with the principles of self determination, sovereign equality and non-interference in the internal affairs of nations.

AND DO HEREBY ADOPT
________________________________________
The following programme of action as a framework for ASEAN cooperation.

A. POLITICAL
1. Meeting of the Heads of Government of the member states as and when necessary.

2. Signing of the Treaty of Amity and Cooperation in Southeast Asia.

3. Settlement of intra-regional disputes by peaceful means as soon as possible.

4. Immediate consideration of initial steps towards recognition of and respect for the Zone of Peace, Freedom and Neutrality wherever possible.

5. Improvement of ASEAN machinery to strengthen political cooperation.

6. Study on how to develop judicial cooperation including the possibility of an ASEAN Extradition Treaty.

7. Strengthening of political solidarity by promoting the harmonization of views, coordinating position and, where possible and desirable, taking common actions.

B. ECONOMIC
1. Cooperation on Basic Commodities, particularly Food and Energy
i) Member states shall assist each other by according priority to the supply of the individual ~country's needs in critical circumstances, and priority to the acquisition of exports from member states, in respect of basic commodities, particularly food and energy.

ii) Member states shall also intensify cooperation in the production of basic commodities particularly food and energy in the individual member states of the region.
2. Industrial Cooperation
i) Member states shall cooperate to establish large-scale ASEAN industrial plants particularly to meet regional requirements of essential commodities.

ii) Priority shall be given to projects which utilize the available materials in the member states, contribute to the increase of food production, increase foreign exchange earnings or save foreign exchange and create employment.

3. Cooperation in Trade
i) Member states shall cooperate in the fields of trade in order to promote development and growth of new production and trade and to improve the trade structures of individual states and among countries of ASEAN conducive to further development and to safeguard and increase their foreign exchange earnings and reserves.

ii) Member states shall progress towards the establishment of preferential trading arrangements as a long term objective on a basis deemed to be at any particular time appropriate through rounds of negotiations subject to the unanimous agreement of member states.

iii) The expansion of trade among member states shall be facilitated through cooperation on basic commodities, particularly in food and energy and through cooperation in ASEAN industrial projects.

iv) Member states shall accelerate joint efforts to improve access to markets outside ASEAN for their raw material and finished products by seeking the elimination of all trade barriers in those markets, developing new usage for these products and in adopting common approaches and actions in dealing with regional groupings and individual economic powers.

v) Such efforts shall also lead to cooperation in the field of technology and production methods in order to increase the production and to improve the quality of export products, as well as to develop new export products with a view to diversifying exports.
4. Joint Approach to International Commodity Problems and Other World Economic Problems
i) The principle of ASEAN cooperation on trade shall also be reflected on a priority basis in joint approaches to international commodity problems and other world economic problems such as the reform of international trading system, the reform on international monetary system and transfer of real resources, in the United Nations and other relevant multilateral fora, with a view to contributing to the establishment of the New International Economic Order.

ii) Member states shall give priority to the stabilisation and increase of export earnings of those commodities produced and exported by them through commodity agreements including bufferstock schemes and other means.
5 . Machinery for Economic Cooperation

Ministerial meetings on economic matters shall be held regularly or as deemed necessary in order to :
i) formulate recommendations for the consideration of Governments of member states for the strengthening of ASEAN economic cooperation;
ii) review the coordination and implementation of agreed ASEAN programmes and projects on economic cooperation;
iii) exchange views and consult on national development plans and policies as a step towards harmonizing regional development; and
iv) perform such other relevant functions as agreed upon by the member Governments.

\
C. SOCIAL

1. Cooperation in the field of social development, with emphasis on the well being of the low-income group and of the rural population, through the expansion of opportunities for productive employment with fair remuneration.

2. Support for the active involvement of all sectors and levels of the ASEAN communities, particularly the women and youth, in development efforts.

3. Intensification and expansion of existing cooperation in meeting the problems of population growth in the ASEAN region, and where possible, formulation of new strategies in collaboration with appropriate international agencies.

4. Intensification of cooperation among members states as well as with the relevant international bodies in the prevention and eradication of the abuse of narcotics and the illegal trafficking of drugs.

D. CULTURAL AND INFORMATION
1. Introduction of the study of ASEAN, its member states and their national languages as part of the curricula of schools and other institutions of learning in the member states.

2. Support of ASEAN scholars, writers, artists and mass media representatives to enable them to play an active role in fostering a sense of regional identity and fellowship.

3. Promotion of Southeast Asian studies through closer collaboration among national institutes.

E. SECURITY

Continuation of cooperation on a non-ASEAN basis between the member states in security matters in accordance with their mutual needs and interests.


F. IMPROVEMENT OF ASEAN MACHINERY
1. Signing of the Agreement on the Establishment of the ASEAN Secretariat.

2. Regular review of the ASEAN organizational structure with a view to improving its effectiveness.

3. Study of the desirability of a new constitutional framework for ASEAN.

DONE, at Denpasar, Bali, this Twenty-Fourth Day of February in the year One Thousand Nine Hundred and Seventy-Six.

Doktrin Obama

Rangkuman Materi ”Doktrin Obama”

Pada akhir tahun 2008, seluruh dunia tertuju ke kota Washington DC. Di tempat itulah Amerika Serikat melantik Presiden yang baru yaitu Barack Husein Obama. Kemenangan Obama dalam Pemilihan Presiden Amerika Serikat telah membuat masyarakat Amerika dan dunia menanti kebijakan seperti apa yang akan ia ambil untuk Amerika. Karena ketika masa kampanye calon presiden, ia selalu menggunakan kata ”Perubahan” untuk mendapatkan dukungan warga Amerika Serikat.
Banyak kalangan masyarakat percaya bahwa pemerintahan Presiden Barack Obama akan berbeda dengan pemerintahan sebelumnya. Terutama dalam hal mengambil kebijakan politik luar negeri Amerika Serikat.

Namun sebelum itu, kita harus mengetahui garis besar atau arah tujuan politik luar negeri Amerika Serikat.
1. Menciptakan stabilitas keamanan dunia internasional.
2. Menyebarkan demokrasi.
3. Penyebaran nilai-nilai liberalisme.

Semua arah tujuan tersebut dikarenakan telah menurunnya citra Amerika Serikat di mata masyarakat internasional. Meskipun di kalangan antar negara, AS masih disegani, namun pada masyarakat internasional, citra AS sudah turun. Ini bisa terjadi karena kebijakan-kebijakan politik luar negeri AS pada pemerintahan sebelumnya tidak tepat sasaran, terutama dalam bidang militer. Contoh jelasnya yaitu pada tahun 2003, Amerika Serikat menginvasi Irak karena Irak dianggap mempunyai senjata biologis pemusnah masal. Amerika bahkan juga menjatuhkan rezim Sadam Husein di Irak. Namun, apa yang terjadi? hingga kini senjata pemusnah masal tidak ditemukan. Kemudian Irak juga dibuat hancur oleh AS. Kejadian itulah yang membuat masyarakat internasional mengecam tindakan AS.

Kemudian apa yang berbeda antara pemerintahan Barack Obama dengan pemerintahan sebelumnnya seperti George W. Bush dan Bill Clinton?
Pada masa pemerintahan Presiden Bill Clinton, cenderung lebih banyak menggunakan Soft Power dan Hard Power. Soft Power dalam arti menggunakan cara-cara damai seperti diplomasi atau negosiasi. Sedangkan Hard Power yaitu menggunakan cara kekerasan seperti perang, intervensi atau embargo. Kemudian sasaran atau aktor yang dituju adalah negara. Era Clinton lebih sering menggunakan pengembangan strategis dalam hal Diplomation (Diplomasi) dan Development (Pembangunan).
Pada masa pemerintahan George W. Bush lebih banyak menggunakan Hard Power. Ini dikarenakan terjadinya serangan ke gedung WTC tanggal 11 September 2001 yang dilakukan oleh sekelompok teroris. Sejak kejadian itu, Bush mengambil kebijakan untuk berperang melawan teroris. Bisa dikatakan era Bush ini lebih mementingkan pengembangan strategis dalam hal Defense (Pertahanan). Maka, ia mengirim tentara Amerika Serikat ke berbagai penjuru dunia terutama Timur Tengah yang ia anggap sebagai sarang teroris. Ketika AS menginvasi Irak, itu merupakan keputusan sepihak yang belum mendapatkan persetujuan dari PBB.
Lalu, langkah-langkah apa yang digunakan Presiden Barack Obama? Hingga saat ini, Obama cenderung menggunakan Soft Power. Ia lebih mengedepankan cara-cara damai di dalam dunia internasional. Selain itu, ia juga mengedepankan kerjasama antar negara. Ia menekankan pengembangan strategis dalam hal Diplomation, Development dan Defense atau yang dikenal dengan 3D. Selain itu, Obama tidak lagi hanya interaksi antar negara namun juga memperbanyak berinteraksi dengan masyarakat biasa atau non-state. Ini terlihat ketika, Menteri Luar Negeri AS, Hillary Clinton, mengunjungi Indonesia. Ia tidak hanya menemui kepala negara dan pejabat negara, namun juga bertemu dengan LSM, aktivis, masyarakat biasa. Bahkan, ia juga mengunjungi Kamar Mandi Umum yang didanai USAID. Ini semua dilakukan untuk menarik simpati masyarakat biasa terhadap Amerika Serikat.
Kemudian, apa itu Doktrin Obama? Doktrin Obama adalah langkah-langkah yang diambil oleh Presiden Obama terutama dalam hal kebijakan militer di luar negeri.
• Penggunaan kekuatan militer di luar negeri hanya akan dilakukan apabila sasaran sudah benar-benar jelas, tidak hanya berdasarkan dugaan-dugaan dan laporan interlijen yang tidak tepat.
• Biaya pengerahan kekuatan militer ke luar negeri harus dipertimbangkan dan harus komunikasikan kepada rakyat.
• Penggunaan kekuatan militer merupakan pilihan terakhir setelah upaya-upaya diplomatik dilakukan.
• Penggunaan kekuatan militer dilakukan setelah mendapatkan dukungan serta bekerjasama dengan negara-negara sekutu secara multilateral.

Semua itu dilakukan dengan maksud agar sasaran berikut ini bisa tercapai.
• Mengembalikan citra Amerika Serikat di masyarakat internasional.
• Mencapai sasaran strategis Amerika Serikat.
• Confidence Building Measurement.

Krisis Ekonomi dan Keuangan

Crisis theory
Crisis theory is a debate within the Marxian theory of political economy. It is concerned with explaining the business cycle in capitalism, particularly recession, drawing on Karl Marx's account of value relations.
Marx believed he had provided a comprehensive account of the inner dynamics of capitalist social organization. According to those who understand him to have offered a complete crisis theory, Marx demonstrated that the particular form social investment takes under capitalism, c:v (constant capital : variable capital), works initially to accelerate, but latterly to strangle the long-wave development of mankind's means of production proportional to our labour power, M:L. Given that the advancement of M:L is the foundation of all material progress and thus social progress for Marx, proving that capitalism retards M:L is all the proof Marx needed that capitalism was becoming obsolete. The alternative to replacing capitalism would be for its ever-present crisis to drag humanity back to barbarism, destroying the gains that capitalism itself had created.
Marx's precise workings-out, with their reliance on a customized version of the dialectic method Marx salvaged from Hegel, resist summarization. However, the important sections come in Capital Volume 3, particularly in Part 3 - The Law of the Tendency of the Rate of Profit to Fall. An attempt was made to re-present aspects of them in a mathematical form in the work of Henryk Grossman. Central to the argument is the claim that, within a given business cycle, the accumulation of surplus from year to year leads to a kind of top-heaviness, in which a relatively fixed number of workers have to add profit to an ever-larger lump of investment capital. This observation leads to what is known as Marx's law of the tendency of the rate of profit to fall. Unless certain countermeasures are available to be taken, the exponential growth of capital out-paces the growth in labor productivity, so the profits of economic activity have to be shared out more thinly among capitals, i.e., at a lower profit rate. When countermeasures are unavailable or exhausted, the system requires the destruction of capital values in order to return to profitability.
Influence
The place of crisis theory within Marx's theory is central and recurs throughout his writings and correspondence. This is one of the abiding and most revolutionary aspects of Marx's work. Paul Mattick's Economic Crisis and Crisis Theory published by Merlin Press in 1981 is an accessible introduction and discussion derived from Grossman's work. François Chesnais's[1984] chapter Marx's Crisis Theory Today in Christopher Freeman ed. Design, Innovation and Long Cycles in Economic Development Frances Pinter, London, discussed the continuing relevance of the theory.
External links
• "Crisis of Capitalism" by MIA Encyclopedia of Marxism
• Capital, Volume 1, "Chapter 1" by Karl Marx











1994 economic crisis in Mexico


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The 1994 Economic Crisis in Mexico, widely known as the Mexican peso crisis, became an effective crisis with the sudden devaluation of the Mexican peso in December 1994.
The impact of the Mexican economic crisis on Southern Cone and Brazil was labeled the Tequila Effect (Spanish: Efecto Tequila).
Contents
• 1 Causes of the economic crisis of 1994
• 2 Financial assistance package
• 3 See also
• 4 References
• 5 External links

Causes of the economic crisis of 1994
The crisis is also known in Spanish as el error de diciembre — The December Mistake— a term coined by the then ex-president Carlos Salinas de Gortari. While these critics agree that a devaluation was necessary, they argue that the way it was handled was politically incorrect (although economically coherent). While the crisis took place under President Ernesto Zedillo, the causes are usually attributed to the policy actions and inactions of Carlos Salinas de Gortari's outgoing administration. Salinas de Gortari popularized the term "December Mistake" when he referred to Zedillo's sudden reversal of the former administrative policies of tight currency controls, "a mistake." The Salinas de Gortari's currency policy put a strain on the nation's finances.
As in prior election cycles, a pre-election disposition to stimulate the economy, temporarily and unsustainably, led to post-election economic instability. There were concerns about the level and quality of credit extended by banks during the preceding low-interest rate period, as well as the standards for extending credit. The country's risk premium was also affected by an armed rebellion in Chiapas, causing investors to be wary of investing their money in an unstable region. The Mexican government's finances and cash availability were further hampered by two decades of increasing spending, debt loads, and low oil prices. Its ability to absorb shocks was hampered by its commitments to finance past spending.
Economists Hufbauer and Schott (2005) from the Institute for International Economics have commented on the macroeconomic policy mistakes that precipitated the crisis:
• 1994 was the last year of the sexenio, or 6-year administration of Carlos Salinas de Gortari who, following the PRI tradition on an election year, launched a high spending splurge and a high deficit.
• In order to finance the deficit (7% of GDP current account deficit), Salinas issued the Tesobonos, a type of debt instrument denominated in pesos but indexed to dollars.
• Mexico experienced lax banking or corrupt practices; moreover, some members of the Salinas family collected enormous illicit payoffs.
• The EZLN, an insurgent rebellion, officially declared war on the government on January 1; even though the armed conflict ended two weeks later, the grievances and petitions remained a cause of concern, especially amongst some investors.[1]
Macroeconomics 5th Edition by Mankiw explains the country-risk issues precipitating the crisis:
• The EZLN's violent uprising in Chiapas in 1994 along with the assassination of Presidential candidate Luis Donaldo Colosio made the nation's political future look less certain to investors, who then started placing a larger risk premium on Mexican assets.
• Mexico had a fixed exchange rate system that accepted pesos during the reaction of investors to a higher perceived country risk premium and paid out dollars. However, Mexico lacked sufficient foreign reserves to maintain the fixed exchange rate and was running out of dollars at the end of 1994. The peso then had to be allowed to devalue despite the government's previous assurances to the contrary, thereby scaring investors away and further raising its risk profile.
• When the government tried to roll over some of its debt that was coming due, investors were unwilling to buy the debt and default became one of few options.
• A crisis of confidence damaged the banking system which in turn fed a vicious cycle further affecting investor confidence. [2]
All of the above concerns, along with increasing current account deficit fostered by consumer binding and government spending, caused alarm among those who bought the tesobonos. The investors sold the tesobonos rapidly, depleting the already low central bank reserves. Given the fact that it was an election year, whose outcome might have changed as a result of a pre-election-day economic downturn, Banco de México decided to buy Mexican Treasury Securities to maintain the monetary base, thus keeping the interest rates from rising. This caused an even bigger decline in the dollar reserves. However, nothing was done during the last 5 months of Salinas' administration. Some critics affirm this maintained Salinas' popularity, as he was seeking international support to become director general of the WTO. Zedillo took office on December 1, 1994.
A few days after a private meeting with major Mexican entrepreneurs, in which his administration asked them for their opinion of a planned devaluation; Zedillo announced his government would let the fixed rate band increase to 15 percent (up to 4 pesos per US dollar), by stopping the previous administration's measures to keep it at the previous fixed level. The government, being unable even to hold this line, decided to let it float.
The peso crashed under a floating regime from four pesos to the dollar to 7.2 to the dollar in the space of a week. The United States intervened rapidly, first by buying pesos in the open market, and then by granting assistance in the form of $50 billion in loan guarantees. The dollar stabilized at the rate of 6 pesos per dollar. By 1996, the economy was growing (peaked at 7% growth in 1999). In 1997, Mexico repaid, ahead of schedule, all US Treasury loans.
Financial assistance package


Ernesto Zedillo.
A week of intense currency crisis stabilized some time after the US President Clinton, in concert with international organizations, granted a loan to the Mexican government.[3]
Loans and guarantees to Mexico totaled almost $50 billion, with the following contributions:
• The United States arranged currency swaps and loan guarantees with a $20 billion total value.
• The IMF promised an 18 month Stand-by Credit Agreement of around US $17.7 billion.
• The Bank for International Settlements offered a $10 billion line of credit.
• The Bank of Canada offered short term swaps with a US dollar value of around one billion.
The United States' assistance was provided via the treasury's Exchange Stabilization Fund. This was slightly controversial, as President Clinton tried and failed to pass the Mexican Stabilization Act through Congress. However, use of the ESF allowed the provision of funds without the approval of the legislative branch. At the end of the crisis, the U.S. actually made a $500 million profit on the loans.[4]
See also
• Economy of Mexico
• Late 2000s recession
• Mexico
• North American Free Trade Agreement
References
1. ^ HUFBAUER GC, J Schott, NAFTA Revisited: Achievements and Challenges, Institute for International Economics, Washington DC, October, 2005
2. ^ Mankiw:Macroeconomics
3. ^ http://www.usdoj.gov/olc/esf2.htm
4. ^ Alan Greenspan (September 17, 2007). The Age of Turbulence. The Penguin Press. p. 159. ISBN 1594201315.
External links
• The Mexican Economy 1996: Financial Assistance Package - Annual report of the Banco de México
• The Post-Nafta Mexican Peso Crisis: Bailout or Aid? Isolationism or Globalization? by Brett M. Humphrey
• Mindmapping for Economic Crisis of Mexico
Retrieved from "http://en.wikipedia.org/wiki/1994_economic_crisis_in_Mexico"

















1997 Asian Financial Crisis
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Countries most affected by the Asian Crisis.
The Asian Financial Crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown (financial contagion).
The crisis started in Thailand with the financial collapse of the Thai baht caused by the decision of the Thai government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.[1]
Though there has been general agreement on the existence of a crisis and its consequences, what is less clear is the causes of the crisis, as well as its scope and resolution. Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. The People's Republic of China, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.
Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96, then shot up beyond 180% during the worst of the crisis. In Korea, the ratios rose from 13-21% and then as high as 40%, while the other Northern NICs (Newly Industrialized Countries) fared much better. Only in Thailand and Korea did debt service-to-exports ratios rise. [2]
Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down in May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In the Philippines growth dropped to virtually zero in 1998. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover.[3]
Contents
[hide]
• 1 History
• 2 IMF Role
o 2.1 IMF and High Interest Rates
• 3 Thailand
• 4 Indonesia
• 5 South Korea
• 6 Philippines
• 7 Hong Kong
• 8 Malaysia
• 9 Singapore
• 10 China
• 11 United States and Japan
• 12 Consequences
o 12.1 Asia
o 12.2 Outside Asia
• 13 See also
• 14 Notes
• 15 References
o 15.1 Books
o 15.2 Papers
o 15.3 Other
• 16 External links

[edit] History
Until 1997, Asia attracted almost half of the total capital inflow from developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian economic miracle".
In 1994, noted economist Paul Krugman published an article attacking the idea of an "Asian economic miracle".[4] He argued that East Asia's economic growth had historically been the result of increasing capital investment. However, total factor productivity had increased only marginally or not at all. Krugman argued that only growth in total factor productivity, and not capital investment, could lead to long-term prosperity. Krugman's views would be seen by many as prescient after the financial crisis had become full-blown[neutrality disputed], though he himself stated that he had not predicted the crisis nor foreseen its depth.
The causes of the debacle are many and disputed. Thailand's economy developed into a bubble fueled by "hot money". More and more was required as the size of the bubble grew. The same type of situation happened in Malaysia, and Indonesia, which had the added complication of what was called "crony capitalism".[5] The short-term capital flow was expensive and often highly conditioned for quick profit. Development money went in a largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those closest to the centers of power.[6]
At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to change their economic environment. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had attracted hot money flows through high short-term interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus making their exports less competitive. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.
Some economists have advanced the growing exports of China as a contributing factor to ASEAN nations' export growth slowdown, though these economists maintain the main cause of the crises was excessive real estate speculation.[7] China had begun to compete effectively with other Asian exporters particularly in the 1990s after the implementation of a number of export-oriented reforms. Other economists dispute China's impact, noting that both ASEAN and China experienced simultaneous rapid export growth in the early 1990s.[8]
Many economists believe that the Asian crisis was created not by market psychology or technology, but by policies that distorted incentives within the lender-borrower relationship. The resulting large quantities of credit that became available generated a highly-leveraged economic climate, and pushed up asset prices to an unsustainable level.[9] These asset prices eventually began to collapse, causing individuals and companies to default on debt obligations. The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. In order to prevent a collapse of the currency values, these countries' governments were forced to raise domestic interest rates to exceedingly high levels (to help diminish the flight of capital by making lending to that country relatively more attractive to investors) and to intervene in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves. Neither of these policy responses could be sustained for long. Very high interest rates, which can be extremely damaging to an economy that is relatively healthy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis.
Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in the crisis compared to the financial markets. The rapidity with which the crisis happened has prompted Sachs and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary and contractory fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis, while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a "herd mentality" among investors that magnified a relatively small risk in the real economy. The crisis had thus attracted interest from behavioral economists interested in market psychology. Another possible cause of the sudden risk shock may also be attributable to the handover of Hong Kong sovereignty on 1 July 1997. During the 1990s, hot money flew into the Southeast Asia region but investors were often ignorant of the actual fundamentals or risk profiles of the respective economies. The uncertainty regarding the future of Hong Kong led investors to shrink even further away from Asia, exacerbating economic conditions in the area (subsequently leading to the devaluation of the Thai baht on 2 July 1997).[10]
The foreign ministers of the 10 ASEAN countries believed that the well co-ordinated manipulation of their currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruining Malaysia's economy with "massive currency speculation." (Soros appeared to have had his bets in against the Asian currency devaluations, incurring a loss when the crisis hit.[citation needed]) At the 30th ASEAN Ministerial Meeting held in Subang Jaya, Malaysia, they issued a joint declaration on 25 July 1997 expressing serious concern and called for further intensification of ASEAN's cooperation to safeguard and promote ASEAN's interest in this regard.[11] Coincidentally, on that same day, the central bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific) meeting in Shanghai, and they failed to make the 'New Arrangement to Borrow' operational. A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available under the 'General Agreement to Borrow' and the 'Emergency Finance Mechanism'. As such, the crisis could be seen as the failure to adequately build capacity in time to prevent Currency Manipulation. This hypothesis enjoyed little support among economists, however, who argue that no single investor could have had enough impact on the market to successfully manipulate the currencies' values. In addition, the level of organization necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate their values rendered this possibility remote.
[edit] IMF Role
Such was the scope and the severity of the collapses involved that outside intervention, considered by many as a new kind of colonialism,[12] became urgently needed. Since the countries melting down were among not only the richest in their region, but in the world, and since hundreds of billions of dollars were at stake, any response to the crisis had to be cooperative and international, in this case through the International Monetary Fund (IMF). The IMF created a series of bailouts ("rescue packages") for the most affected economies to enable affected nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency, banking, and financial systems as much like those of the United States and Europe as possible. In other words, the IMF's support was conditional on a series of drastic economic reforms influenced by neoliberal economic principles called a "structural adjustment package" (SAP). The SAPs called on crisis-struck nations to cut back on government spending to reduce deficits, allow insolvent banks and financial institutions to fail, and aggressively raise interest rates. The reasoning was that these steps would restore confidence in the nations' fiscal solvency, penalize insolvent companies, and protect currency values. Above all, it was stipulated that IMF-funded capital had to be administered rationally in the future, with no favored parties receiving funds by preference. There were to be adequate government controls set up to supervise all financial activities, ones that were to be independent, in theory, of private interest. Insolvent institutions had to be closed, and insolvency itself had to be clearly defined. In short, exactly the same kinds of financial institutions found in the United States and Europe had to be created in Asia, as a condition for IMF support. In addition, financial systems had to become "transparent", that is, provide the kind of reliable financial information used in the West to make sound financial decisions.[13]
However, the greatest criticism of the IMF's role in the crisis was targeted towards its response.[14] As country after country fell into crisis, many local businesses and governments that had taken out loans in US dollars, which suddenly became much more expensive relative to the local currency which formed their earned income, found themselves unable to pay their creditors. The dynamics of the situation were closely similar to that of the Latin American debt crisis. The effects of the SAPs were mixed and their impact controversial. Critics, however, noted the contractionary nature of these policies, arguing that in a recession, the traditional Keynesian response was to increase government spending, prop up major companies, and lower interest rates. The reasoning was that by stimulating the economy and staving off recession, governments could restore confidence while preventing economic loss. They pointed out that the U.S. government had pursued expansionary policies, such as lowering interest rates, increasing government spending, and cutting taxes, when the United States itself entered a recession in 2001.
Although such reforms were, in most cases, long needed, the countries most involved ended up undergoing an almost complete political and financial restructuring. They suffered permanent currency devaluations, massive numbers of bankruptcies, collapses of whole sectors of once-booming economies, real estate busts, high unemployment, and social unrest. For most of the countries involved, IMF intervention has been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that many locals called the financial crisis the "IMF crisis".[15] Many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk.[14]
[edit] IMF and High Interest Rates
The conventional high-interest-rate economic wisdom is normally employed by monetary authorities to attain the chain objectives of tightened money supply, discouraged currency speculation, stabilized exchange rate, curbed currency depreciation, and ultimately contained inflation.
In the Asian meltdown, highest IMF officials rationalized their prescribed high interest rates as follows:
From then IMF First Deputy Managing Director, Stanley Fischer (Stanley Fischer, "The IMF and the Asian Crisis," Forum Funds Lecture at UCLA, Los Angeles on March 20, 1998):
”When their governments "approached the IMF, the reserves of Thailand and Korea were perilously low, and the Indonesian Rupiah was excessively depreciated. Thus, the first order of business was...to restore confidence in the currency. To achieve this, countries have to make it more attractive to hold domestic currency, which in turn, requires increasing interest rates temporarily, even if higher interest costs complicate the situation of weak banks and corporations….
"Why not operate with lower interest rates and a greater devaluation? This is a relevant tradeoff, but there can be no question that the degree of devaluation in the Asian countries is excessive, both from the viewpoint of the individual countries, and from the viewpoint of the international system. Looking first to the individual country, companies with substantial foreign currency debts, as so many companies in these countries have, stood to suffer far more from… currency (depreciation) than from a temporary rise in domestic interest rates…. Thus on macroeconomics… monetary policy has to be kept tight to restore confidence in the currency…."
From the then IMF Managing Director Michel Camdessus himself ("Doctor Knows Best?" Asiaweek, July 17, 1998, p. 46):
"To reverse (currency depreciation), countries have to make it more attractive to hold domestic currency, and that means temporarily raising interest rates, even if this (hurts) weak banks and corporations."
IMF’s high-interest-rate prescription in the Asian turmoil was quite controversial because it was not the moderate increase in interest rates of usually fraction of one percent, as done in both advanced and developing nations during normal times, but bad-loan provoking high bank lending rates of as much as 60%, as actually implemented during the crisis, especially in the Philippines and Indonesia which had to bear peak non-prime high interest rates of up to 40% and 65%, respectively. The high interest rates were a matter of record in the crisis-hit Asian nations.
[edit] Thailand
Further information: Economy of Thailand
From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time. Inflation was kept reasonably low within a range of 3.4-5.7%[16]. The baht was pegged at 25 to the US dollar.
On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the U.S. dollar, against international speculators. Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and 600'000 foreign workers being sent back to their home countries.[17] The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed.[18]
The Thai government was eventually forced to float the Baht, on 2 July 1997. On 11 August 1997, the IMF unveiled a rescue package for Thailand with more than $17 billion, subject to conditions such as passing laws relating to bankruptcy (reorganizing and restructuring) procedures and establishing strong regulation frameworks for banks and other financial institutions. The IMF approved on 20 August, 1997, another bailout package of $3.9 billion.
Thai opposition parties claimed that former Prime Minister Thaksin Shinawatra had profited from the devaluation,[19] It is now being investigated by the court of justice.
By 2001, Thailand's economy had recovered. The increasing tax revenues allowed the country to balance its budget and repay its debts to the IMF in 2003, four years ahead of schedule. Thailand can finally free from debt and this was successfully done by the government lead by Prime Minister Taksin Shinawatra. The Thai baht continued to appreciate to 34 Baht to the Dollar in July 2008.
[edit] Indonesia
See also: Fall of Suharto and Economy of 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 rupiah had 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 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'.
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. The inflation of the rupiah and the resulting steep hikes in the prices of food staples led to rioting throughout the country in which more than 500 people died in Jakarta alone. In February 1998, President Suharto sacked the governor of Bank Indonesia, but this had proved insufficient. Suharto was forced to resign in mid-1998 and B. J. Habibie became President. Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2000 rupiah to 1 USD. The rate had plunged to over 18000 rupiah to 1 USD at various points during the crisis. Indonesia lost 13.5% of its GDP that year.
[edit] South Korea
Further information: Economy of South Korea
Macroeconomic fundamentals in South Korea were good but the banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions. During that time, there was a haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure returns and profitability. The Korean conglomerates, more or less completely controlled by the government, simply absorbed more and more capital investment. Eventually, excess debt led to major failures and takeovers. For example, in July 1997, South Korea's third-largest car maker, Kia Motors, asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December. That contributed to a further decline in Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms. In 1998, Hyundai Motors took over Kia Motors. Samsung Motors' $5 billion dollar venture was dissolved due to the crisis, and eventually Daewoo Motors was sold to the American company General Motors (GM).
The South Korean won, meanwhile, weakened to more than 1,700 per dollar from around 800. Despite an initial sharp economic slowdown and numerous corporate bankruptcies, Korea has managed to triple its per capita GDP in dollar terms since 1997. Indeed, it resumed its role as the world's fastest-growing economy -- since 1960, per capita GDP has grown from $80 in nominal terms to more than $21,000 as of 2007. However, like the chaebol, South Korea's government did not escape unscathed. Its national debt-to-GDP ratio more than doubled (app. 13% to 30%) as a result of the crisis.
In Korea, the crisis is also commonly referred to as the IMF crisis.
[edit] Philippines
Further information: Economy of the Philippines
The Philippine central bank raised interest rates by 1.75 percentage points in May 1997 and again by 2 points on 19 June. Thailand triggered the crisis on 2 July and on 3 July, the Philippine Central Bank was forced to intervene heavily to defend the peso, raising the overnight rate from 15% to 32% right upon the onset of the Asian crisis in mid-July 1997. The peso fell significantly, from 26 pesos per dollar at the start of the crisis, to 38 pesos as of mid-1999, and to 54 pesos as of first half August 2001.
The Philippine economy recovered from a contraction of 0.6% in GDP during the worst part of the crisis to GDP growth of some 3% by 2001, despite scandals of the administration of Joseph Estrada in 2001, most notably the "jueteng" scandal, causing the PSE Composite Index, the main index of the Philippine Stock Exchange, to fall to some 1000 points from a high of some 3000 points in 1997. The peso fell even further, trading at levels of about 55 pesos to the US dollar. Later that year, Estrada was on the verge of impeachment but his allies in the senate voted against the proceedings to continue further. This led to popular protests culminating in the "EDSA II Revolution", which finally forced his resignation and elevated Gloria Macapagal-Arroyo to the presidency. Arroyo managed to lessen the crisis in the country, which led to the recovery of the Philippine peso to about 50 pesos by the year's end and traded at around 41 pesos to a dollar by end 2007. The stock market also reached an all time high in 2007 and the economy is growing by at least more than 7 percent, its highest in nearly 2 decades.
[edit] Hong Kong
Further information: Economy of Hong Kong
Although the two events were unrelated, the collapse of the Thai baht on 2 July 1997, came only 24 hours after the United Kingdom handed over sovereignty of Hong Kong to the People's Republic of China. In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency. Since Hong Kong had more than US$80 billion in foreign reserves, which is equivalent to 700% of its M1 money supply and 45% of its M3 money supply, the Hong Kong Monetary Authority (effectively the city's central bank) managed to maintain the peg.
Stock markets became more and more volatile; between 20 October and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators were taking advantage of the city's unique currency-board system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August.
The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies,[20] and became the largest shareholder of some of those companies (e.g. the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. The Government started selling those shares in 2001, making a profit of about HK$30 billion (US$4 billion).
[edit] Malaysia
Further information: Economy of Malaysia
Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world (with turnover exceeding even markets with far higher capitalization like the NYSE). Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.
In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 3.80 to the dollar.
In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points. In September that year, various defensive measures were announced in order to overcome the crisis. The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalized banks.
Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion surplus.[21] Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it did not appear to be a free float, but a managed float, like the Singapore dollar.
[edit] Singapore
Further information: Economy of Singapore
As the financial crisis spread the economy of Singapore dipped into a short recession. The relatively short duration and milder effect on its economy was credited to the active management by the government. For example, the Monetary Authority of Singapore allowed for a gradual 20% depreciation of the Singapore dollar to cushion and guide the economy to a soft landing. The timing of government programs such as the Interim Upgrading Program and other construction related projects were brought forward. Instead of allowing the labor markets to work, the National Wage Council pre-emptively agreed to Central Provident Fund cuts to lower labor costs, with limited impact on disposable income and local demand. Unlike in Hong Kong, no attempt was made to directly intervene in the capital markets and the Straits Times Index was allowed to drop 60%. In less than a year, the Singaporean economy fully recovered and continued on its growth trajectory.[22]
[edit] China
Further information: Economy of the People's Republic of China
The Chinese currency, the renminbi (RMB), had been pegged to the US dollar at a ratio of 8.3 RMB to the dollar, in 1994. Having largely kept itself above the fray throughout 1997-1998 there was heavy speculation in the Western press that China would soon be forced to devalue its currency to protect the competitiveness of its exports vis-a-vis those of the ASEAN nations, whose exports became cheaper relative to China's. However, the RMB's non-convertibility protected its value from currency speculators, and the decision was made to maintain the peg of the currency, thereby improving the country's standing within Asia. The currency peg was partly scrapped in July 2005 rising 2.3% against the dollar, reflecting pressure from the United States.
Unlike investments of many of the Southeast Asian nations, almost all of China's foreign investment took the form of factories on the ground rather than securities, which insulated the country from rapid capital flight. While China was relatively unaffected by the crisis compared to Southeast Asia and South Korea, GDP growth slowed sharply in 1998 and 1999, calling attention to structural problems within its economy. In particular, the Asian financial crisis convinced the Chinese government of the need to resolve the issues of its enormous financial weaknesses, such as having too many non-performing loans within its primitive and inefficient banking system, and relying heavily on trade with the United States.
[edit] United States and Japan
Further information: Economy of the United States and Economy of Japan
The "Asian flu" had also put pressure on the United States and Japan. Their markets did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554 points or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence (see 27 October 1997 mini-crash). Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together; about 40% of Japan's exports go to Asia. The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South Korea's devalued currency, and China's steady gains, many companies complained outright that they could not compete.[23]
Another longer-term result was the changing relationship between the U.S. and Japan, with the U.S. no longer openly supporting the highly artificial trade environment and exchange rates that governed economic relations between the two countries for almost five decades after World War II.[24]
[edit] Consequences
[edit] Asia
The crisis had significant macro-level effects, including sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries.[25] The nominal US dollar GDP of ASEAN fell by US$9.2 billion in 1997 and $218.2 billion (31.7%) in 1998. In Korea, the $170.9 billion fall in 1998 was equal to 33.1% of the 1997 GDP.[26] Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 1997-1998. Indonesia, South Korea and Thailand were the countries most affected by the crisis.
Currency Exchange rate
(per US$1)[27]
Change
June 1997 July 1998
Thai baht
24.5 41 - 40.2%
Indonesian rupiah
2,380 14,150 - 83.2%
Philippine peso
26.3 42 - 37.4%
Malaysian ringgit
2.5 4.1 - 39.0%
South Korean won
850 1,290 - 34.1%
Country GNP (US$1 billion)[27]
Change
June 1997 July 1998
Thailand
170 102 - 40.0%
Indonesia
205 34 - 83.4%
Philippines
75 47 - 37.3%
Malaysia
90 55 - 38.9%
South Korea
430 283 - 34.2%

The economic crisis also led to a political upheaval, most notably culminating in the resignations of President Suharto in Indonesia and Prime Minister General Chavalit Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment, with George Soros and the IMF in particular singled out as targets of criticisms. Heavy U.S. investment in Thailand ended, replaced by mostly European investment, though Japanese investment was sustained.[citation needed] Islamic and other separatist movements intensified in Southeast Asia as central authorities weakened.[28]
More long-term consequences included reversal of the relative gains made in the boom years just preceding the crisis. Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in Korea and 12.5% in the Philippines. [26] The CIA World Factbook reported that the per capita income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it declined from $4,600 to $3,700; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per capita income rose from $6,500 to $9,300.[29] Indeed, the CIA's analysis asserted that the economy of Indonesia was still smaller in 2005 than it had been in 1997, suggesting an impact on that country similar to that of the Great Depression. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China and India.[30]
The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens of countries, had a direct impact on the livelihood of millions, happened within the course of a mere few months, and at each stage of the crisis leading economists, in particular the international institutions, seemed a step behind. Perhaps more interesting to economists was the speed with which it ended, leaving most of the developed economies unharmed. These curiosities have prompted an explosion of literature about financial economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against the conduct of the IMF in the crisis, including one by former World Bank economist Joseph Stiglitz. Politically there were some benefits. In several countries, particularly South Korea and Indonesia, there was renewed push for improved corporate governance. Rampaging inflation weakened the authority of the Suharto regime and led to its toppling in 1998, as well as accelerating East Timor's independence.[31]
[edit] Outside Asia
After the Asian crisis, international investors were reluctant to lend to developing countries, leading to economic slowdowns in developing countries in many parts of the world. The powerful negative shock also sharply reduced the price of oil, which reached a low of $8 per barrel towards the end of 1998, causing a financial pinch in OPEC nations and other oil exporters. This reduction in oil revenue contributed to the 1998 Russian financial crisis, which in turn caused Long-Term Capital Management in the United States to collapse after losing $4.6 billion in 4 months. A wider collapse in the financial markets was avoided when Alan Greenspan and the Federal Reserve Bank of New York organized a $3.625 billion bail-out. Major emerging economies Brazil and Argentina also fell into crisis in the late 1990s (see Argentine debt crisis).[32]
The crisis in general was part of a global backlash against the Washington Consensus and institutions such as the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise of the anti-globalization movement in 1999. Four major rounds of world trade talks since the crisis, in Seattle, Doha, Cancún, and Hong Kong, have failed to produce a significant agreement as developing countries have become more assertive, and nations are increasingly turning toward regional or bilateral FTAs (Free Trade Agreements) as an alternative to global institutions. Many nations learned from this, and quickly built up foreign exchange reserves as a hedge against attacks, including Japan, China, South Korea. Pan Asian currency swaps were introduced in the event of another crisis. However, interestingly enough, such nations as Brazil, Russia, and India as well as most of East Asia began copying the Japanese model of weakening their currencies, restructuring their economies so as to create a current account surplus to build large foreign currency reserves. This has led to an ever increasing funding for US treasury bonds, allowing or aiding housing (in 2001-2005) and stock asset bubbles (in 1996-2000) to develop in the United States.
[edit] See also
• Financial crisis
• Financial contagion
• List of finance topics
[edit] Notes
1. ^ Kaufman: pp. 195-6
2. ^ http://www.adb.org/Documents/Books/Key_Indicators/2003/pdf/rt29.pdf
3. ^ Pempel: pp 118-143
4. ^ The Myth of Asia's Miracle A Cautionary Fable by Paul Krugman.
5. ^ Hughes, Helen. Crony Capitalism and the East Asian Currency Financial 'Crises'. Policy. Spring 1999.
6. ^ Blustein: p. 73
7. ^ The Three Routes to Financial Crises: The Need for Capital Controls. Gabriel Palma (Cambridge University). Center for Economic Policy Analysis. November 2000.
8. ^ Bernard Eccleston, Michael Dawson, Deborah J. McNamara (1998). The Asia-Pacific Profile. Routledge (UK). ISBN 0415172799. http://books.google.com/books?visbn=0415172799&id=l07ak-yd6DAC&pg=RA1-PA311&lpg=RA1-PA311&ots=XgqmmGV3CC&dq=%22Bangkok+Declaration%22+ASEAN&ie=ISO-8859-1&output=html&sig=u2ddDhzn-yVhEn5Fwu3d8iih0OA.
9. ^ FIRE-SALE FDI by Paul Krugman.
10. ^ Stiglitz: pp. 12-16
11. ^ Joint Comminuque The 30th ASEAN Ministerial Meeting (AMM) The Thirtieth ASEAN Ministerial Meeting was held in Subang Jaya, Malaysia from 24 - 25 July 1997.
12. ^ Halloran, Richard. China's Decisive Role in the Asian Financial Crisis. Global Beat Issue Brief No. 24. 27 January 1998.
13. ^ Noland: pp. 98-103
14. ^ a b IMF's Role in the Asian Financial Crisis by Walden Bello.
15. ^ The IMF Crisis Editorial. Wall Street Journal. 15 April 1998.
16. ^ http://www.columbia.edu/cu/thai/html/financial97_98.html
17. ^ Kaufman: pp. 193-8
18. ^ Liebhold, David. Thailand's Scapegoat? Battling extradition over charges of embezzlement, a financier says he's the fall guy for the 1997 financial crash. TIME.com. 27 December 1999.
19. ^ Pressure from below: Supporters of the new, improved Constitution now have to help turn words into action 10 October 1997
20. ^ Bayani Cruz, We will hold on to blue-chip shares: Tsang, The Standard, 29 August 1998.
21. ^ The CIA World Factbook - Malaysia
22. ^ Ngian Kee Jin: p. 12
23. ^ Pettis: pp. 55-60
24. ^ Pettis: p. 79
25. ^ Tiwari: pp. 1-3
26. ^ a b http://www.adb.org/Documents/Books/Key_Indicators/2001/rt11_ki2001.xls
27. ^ a b Cheetham, R. 1998. Asia Crisis. Paper presented at conference, U.S.-ASEAN-Japan policy Dialogue. School of Advanced International Studies of Johns Hopkins University, June 7-9, Washingtion, D.C.
28. ^ Radelet: pp. 5-6
29. ^ The Asian financial crisis ten years later: assessing the past and looking to the future. Janet L. Yellen. Speech to the Asia Society of Southern California, Los Angeles, California, 6 February 2007
30. ^ Kilgour, Andrea (1999). The changing economic situation in Vietnam: A product of the Asian crisis?
31. ^ Weisbrot: p. 6
32. ^ The Crash transcript. PBS Frontline.
[edit] References
[edit] Books
• Kaufman, GG., Krueger, TH., Hunter, WC. (1999) The Asian Financial Crisis: Origins, Implications and Solutions. Springer. ISBN 0792384725
• Pettis, Michael (2001). The Volatility Machine: Emerging Economies and the Threat of Financial Collapse. Oxford University Press. ISBN 0-19-514330-2.
• Blustein, Paul (2001). The Chastening: Inside the Crisis that Rocked the Global Financial System and Humbled the IMF. PublicAffairs. ISBN 1-891620-81-9.
• Noland, Markus, Li-gang Liu, Sherman Robinson, and Zhi Wang. (1998) Global Economic Effects of the Asian Currency Devaluations. Policy Analyses in International Economics, no. 56. Washington, DC: Institute for International Economics.
• Pempel, T. J. (1999) The Politics of the Asian Economic Crisis. Ithaca, NY: Cornell University Press.
• Ries, Philippe. (2000) The Asian Storm: Asia's Economic Crisis Examined.
• Tecson, Marcelo L. (2005) Puzzlers: Economic Sting (The Case Against IMF, Central Banks, and IMF-Prescribed High Interest Rates) Makati City, Philippines: Raiders of the Lost Gold Publication
• Muchhala, Bhumika, ed. (2007) Ten Years After: Revisiting the Asian Financial Crisis[1]. Washington, DC: Woodrow Wilson International Center for Scholars Asia Program.
• Ito, Takatoshi and Andrew K. Rose (2006). Financial Sector Development in the Pacific Rim. University of Chicago Press. ISBN 9780226386843.
[edit] Papers
• Ngian Kee Jin (March 2000). Coping with the Asian Financial Crisis: The Singapore Experience. Institute of Southeast Asian Studies. ISSN 0219-3582
• Tiwari, Rajnish (2003). Post-crisis Exchange Rate Regimes in Southeast Asia, Seminar Paper, University of Hamburg.
• Kilgour, Andrea (1999). The changing economic situation in Vietnam: A product of the Asian crisis?
• S. Radelet, J.D. Sachs, R.N. Cooper, B.P. Bosworth (1998). The East Asian Financial Crisis: Diagnosis, Remedies, Prospects. Brookings Papers on Economic Activity.
• Stiglitz, Joseph (1996). Some Lessons From The East Asian Miracle. The World Bank Research Observer.
• Weisbrot, Mark (August 2007). Ten Years After: The Lasting Impact of the Asian Financial Crisis. Center for Economic and Policy Research.
• Tecson, Marcelo L. (2009), "IMF Must Renounce Its Weapon of Mass Destruction: High Interest Rates" (4-part paper on high-interest-rate fallacies and alternatives, emailed to IMF and others on January 27, 2009)
[edit] Other
• Is Thailand on the road to recovery, article by Australian photo-journalist John Le Fevre that looks at the effects of the Asian Economic Crisis on Thailand's construction industry
• Women bear brunt of crisis, article by Australian photo-journalist John Le Fevre examining the effects of the Asian Economic Crisis on Asia's female workforce
• The Crash (transcript only), from the PBS series Frontline
[edit] External links
• Congressional Research Service report for US Congress
[hide]
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August 17, 1998
Indonesia's Economic and Political Crisis: A Challenge for U.S. Leadership in Asia
by John T. Dori
Backgrounder #1214

Indonesia, the country hardest hit by the Asian economic crisis, is relatively calm now. Last May, however, violent demonstrations and looting resulted in more than 1,000 deaths and hastened the end of President Suharto's 32-year reign. These disturbances had begun as peaceful demonstrations against the Indonesian government's insufficient response to the hardships of the economic crisis. A monetary crisis that began in the summer of 1997 exposed broader financial weakness, causing investors to flee Indonesia's financial markets and leading to the collapse of the country's financial system. This year, Indonesia's economy may contract by 30 percent; unemployment is running at upward of 40 percent.
President B. J. Habibie, Suharto's hand-picked successor, has had to grapple with the enormous challenges of promoting broad economic and political reform simultaneously. He has committed to holding national elections next year, and new political parties are forming in response to his early moves to create a more open political system. Even the students whose protests helped to force out Suharto seem ready to give Habibie a chance.
But the current calm could prove illusory. Predictions of dire food shortages as early as this fall raise the prospect of renewed violence and rioting that could lead to a second Indonesian political crisis. The United States should do what it can to help Indonesia to avoid further economic dislocation and violence, and to safeguard and advance the tentative steps toward economic and political reform that have been made since President Suharto's ouster.
To minimize the chances of widespread hunger leading to renewed social chaos in this strategically important country, the United States should accelerate delivery of emergency humanitarian food assistance. More important, to reduce the possibility even more of future crises, including food shortages, the Clinton Administration should offer Indonesia guidance on sorely needed free-market economic reforms and democratic political reforms. It also should move to rebuild ties with Indonesia's politically important military to encourage its evolution toward civilian rule and increased respect for human rights. Finally, if Indonesia continues on a path of positive economic and political reform, U.S. President Bill Clinton should invite President Habibie to visit Washington, both to express support for the positive strides Indonesia has made and to encourage continuation of the process. By setting Indonesia on the path toward political freedom and renewed economic prosperity, the United States will foster the growth and development of a potential strategic ally and partner in the critically important Southeast Asia region.
INDONESIA'S ECONOMIC COLLAPSE
Indonesia's current economic crisis can be traced to Thailand, in early 1997, where Asia's economic crisis first manifested itself. Thailand's currency, the baht, was the first regional currency to crumble, as a result of several factors including imprudent domestic lending practices, an imbalance between short-term and long-term financing, and an unrealistic exchange rate pegged to the U.S. dollar. International Monetary Fund (IMF) recommendations that Thailand devalue the baht also contributed to this process by undermining confidence in the value of the currency. Currency speculators began a run on the baht when doubts grew about Thailand's ability to maintain the dollar peg. The Bank of Thailand, the country's central bank, attempted to support the value of the baht; but, by early July, its foreign reserves all but depleted, the bank decided to let the baht float. The baht fell quickly by 10 percent and continued to weaken, prompted by a lack of confidence in the fundamental health of Thailand's economy, primarily its banking and financial sectors.
Indonesia's experience was similar. By August 1997, currency speculators had begun to recognize in Indonesia many of the same vulnerabilities that had appeared in Thailand, especially an unhealthy reliance on short-term debt financing. After the fall of oil prices in the late 1980s, Indonesia removed controls on the flow of capital, but moved slowly to deregulate financial services. Some 200 small, private banks were created during this period, but they were poorly managed and prone to make risky or politically motivated loans.
During the 1990s, Indonesian companies took advantage of good economic times to rack up foreign debt, which quickly ballooned to about $80 billion with the rapid depreciation of Indonesia's currency, the rupiah. These loans financed speculative investments in such areas of Indonesia's economy as real estate. Unfortunately for Indonesia, a high proportion of this debt was short-term, carrying an average maturity of 18 months. Such short-term debt arrangements as these are not necessarily risky so long as economic growth and stability proceed apace. After more than 30 years of steady economic progress, businesses did not seem to fear an economic downturn or, least of all, a devaluation of the rupiah, which would make it more difficult for them to repay their short-term, dollar-denominated debt obligations.
But in the wake of Thailand's currency devaluation, Indonesian borrowers came to question the continued strength of the rupiah. They attempted to limit their exposure by selling rupiahs and buying dollars. The rapid flight out of rupiahs and into dollars put a great deal of downward pressure on the value of Indonesia's currency. As was the case in Thailand, Indonesia's central bank at first attempted to prevent the fall of the rupiah's value. But with its foreign reserves dwindling, the central bank eventually decided to let the rupiah float. This set off a rapid depreciation in the value of the rupiah, undoubtedly exacerbated by Indonesia's uncertain political future under President Suharto and a lack of confidence that the corruption-ridden government could deal effectively with the burgeoning crisis.
The collapse of Indonesia's currency brought the country's economy to a standstill that essentially persists to this day. Borrowers are unable to repay their debts. Indonesian banks cannot secure foreign loans. As a result, banks are pushed into insolvency and are unable to provide the credit that could spark economic activity and foster growth. Without access to export financing, exporters are unable to earn hard currency by selling their products abroad. Manufacturers and producers no longer can afford the inputs and raw materials required to assemble their products. Because these manufacturers and producers earn no money from production, they cannot service their debts to banks and other creditors, and the process begins again.
CONTINUING HARDSHIP IN INDONESIA
Although political conditions have stabilized somewhat since President Suharto's resignation, Indonesia's near-term economic forecast remains grim. The economy is set to contract by some 15 percent to 30 percent in 1998. 1 Inflation is likely to reach 80 percent to 100 percent this year. 2 Unemployment probably has passed 40 percent. The rupiah has lost so much of its value that most of the country's banks technically are insolvent and its businesses bankrupt because of their inability to repay their debts. And despite the conclusion of four economic stabilization agreements with the IMF since autumn 1997, Indonesia's economy remains in a state of financial collapse. The fall of the rupiah, along with IMF-inspired rates of interest as high as 50 percent to 60 percent, has made credit prohibitively expensive, further depressing economic activity in the country. 3 Even well-run Indonesian companies have been forced into insolvency by the high rates of interest. It is not surprising, therefore, that half the population has slipped below the poverty line, and that many Indonesians are unable to afford even basic necessities.
In addition, there is the possibility of food shortages. A serious drought last year severely damaged rice production. By early 1998, there were alarming predictions that Indonesia would need 4 to 5 million tons of rice by next year to prevent starvation in some areas. 4 Although the government has imported rice to meet current needs, weather problems may cause further shortages into next year. The government predicts a rice shortfall this year of over 3 million tons; others, however, estimate that shortages may exceed 10 million tons. 5 Indonesia has welcomed food aid. Australia has extended $130 million in humanitarian assistance since 1997. Japan has pledged to give 1 million tons of rice, and the United States has pledged 1.5 million tons of wheat.
But there are hopeful indicators, too. Indonesia possesses great natural resources: oil, natural gas, timber, minerals, and good farmland. Indonesia has built an impressive transport, communications, and education infrastructure, and offers a large consumer market. Indonesia also has a young, well-educated workforce that is very attractive to manufacturing industries. The rupiah, which acts as a barometer of international confidence in Indonesia's financial prospects, has become stronger recently: After bottoming out at more than 17,000 to the dollar under President Suharto, the rupiah has been increasing in value since President Habibie assumed power, reaching the 13,000 mark. Although this level is far from what Indonesia's economy needs to function normally, it demonstrates that international financial markets are prepared to reward Indonesia for demonstrated progress toward economic and political reform and social stability.
NEEDED REFORMS
President Habibie has made some progress toward reforming Indonesia's economy. For example, on July 24, Indonesia's Parliament passed a new bankruptcy measure that will update the country's archaic and inefficient bankruptcy procedures and bring them more closely into accord with those of the United States. 6 It appears, however, that President Habibie's interest in economic reform is geared primarily toward meeting the minimum requirements for the continuation of international financial assistance, which includes a $43 billion IMF financial assistance package tied to an economic reform program. The World Bank and over 30 countries comprising the Consultative Group on Indonesia have pledged another $7.9 billion in aid to Indonesia. 7
Continued large-scale foreign assistance, however, cannot provide a lasting solution to Indonesia's economic crisis. Suharto's government continually hedged or refused to advance needed economic reforms while the IMF and other aid agencies continued to provide assistance. Indeed, organizations like the World Bank reportedly knew their loans to Indonesia were being funneled to Suharto family businesses. The World Bank also turned a blind eye toward corruption in projects it funded and accepted false government economic statistics to allow Indonesia to get better credit ratings. 8 The real answers to Indonesia's economic crisis are to be found in responding to the economy's need for broad reform in its financial, legal, trade, and agricultural sectors. These reforms are needed to respond to the stifling policies of the Suharto years that allowed selected cronies to act above the law, maintain market-distorting monopolies, and sustain unsound banks. The Suharto family is estimated to be worth over $30 billion; President Suharto's allies still remain in control of substantial portions of Indonesia's economy. 9 Significant reforms are needed in the following areas:
FINANCIAL SECTOR REFORM
Key to Indonesia's eventual recovery is the reform and rebuilding of its financial sector, which is the heart of the economy, pumping the credit needed to sustain economic activity. But prior to the onset of the current crisis, Indonesia's banking sector was weak. Easy access to foreign capital in the late 1980s spurred the creation of about 200 small, private banks, in addition to a much smaller number of large banks. This, it now seems, was too many banks for Indonesia's market to sustain, and many were managed poorly and prone to making risky and politically motivated loans. Lax enforcement of central bank rules pointed to a lack of transparency and disguised the fact that many banks were undercapitalized or insolvent even before the onset of the financial crisis. The credibility of the banking system suffered. When the government closed 16 insolvent banks in November 1997, instead of instilling confidence, it led to a run on banks by depositors. This, in turn, caused foreign lenders to deny credit to Indonesian banks, severely depressing economic activity.
Although Indonesia's banking sector does require liquidity, or the ability to make loans, the fundamental requirement is for structural reform to restore foreign confidence and lending. The Indonesian government's closing of 16 insolvent banks last year caused a run on other banks, but it was the correct move to begin banking sector restructuring. Last January, the Indonesia Bank Restructuring Agency (IBRA) was created to rehabilitate unsound banks. The IBRA also is helping to consolidate banks so that Indonesia will have fewer, but more viable, banks. Another IBRA goal is to increase transparency in the banking sector, a goal that may be promoted by a recent decision to have the central bank led by a collective board rather than by an individual governor who could be vulnerable to political influence. 10



LEGAL REFORM
Success in financial sector reform depends heavily on reform of the legal system. For example, even though Indonesia has long had a bankruptcy law, it was very difficult to get enforcement from the courts. Politically connected businessmen could not fail, and thus had less of an incentive to invest responsibly. Average Indonesian citizens, as well as foreign corporations, need to know that one law applies to all. For too long, the family and friends of the Suhartos operated above the law, obtaining special treatment for themselves and their business interests. Even at the provincial level, the economic and political power of the Suharto clan stifled business and job creation. 11
Under President Habibie, legal reform has not received a high priority. 12 Opposition leader Amien Rais noted in early July that the "law applies only to those who are weak." 13 As part of the Ministry of Justice, Indonesia's judges lack independence from the bureaucracy. They also are underpaid, which invites corruption. 14 An independent judiciary would go far to promote the rule of law and greater confidence in Indonesia's economy.
REDUCING TRADE BARRIERS
Under the Suharto regime, Indonesia maintained a number of tariff and nontariff barriers to trade. It is important to reduce or eliminate these barriers to create a better business environment for Indonesians as well as for foreign investors. As a participant in the Association of Southeast Asian Nations (ASEAN) Free Trade Area, Indonesia has pledged to reduce most tariffs on imports to about 5 percent by 2003. U.S. industries, however, have complained about tariffs and taxes that reduce their competitiveness in motorcycles, toys, wine, films, videos, and air conditioning equipment. 15 Licensing requirements have acted as a de facto import ban on such items as motorcycles, wine, films, and videos.
President Suharto used barriers and restrictions, including tariffs and monopolies, to benefit the business interests of his family and political allies. Many Suharto family members ran conglomerates, which, when viewed in total, touched almost every aspect of Indonesia's economy. In one celebrated case that Indonesia lost before the World Trade Organization (WTO), the country was ruled as having broken WTO rules by giving tax breaks to President Suharto's son, Hutomo Mandala Putra (also known as Tommy Suharto) to allow him to import Korean cars, thereby putting all other car importers at a disadvantage. 16 Long-time Suharto ally "Bob" Hasan had a virtual monopoly on the lucrative plywood trade. Such intervention in the market on behalf of a chosen few denies opportunity to new and potentially more competitive companies, which, over time, weakens a country's competitiveness.
AGRICULTURAL REFORM
It is essential that Indonesia's government tackle the difficult task of reducing its role in the agricultural sector and giving more power to market forces. That agriculture employs 55 percent of the Indonesian workforce 17 makes such reforms politically sensitive. The Suharto regime promoted self-sufficiency in food grains like rice as a nationalist goal, which served also to promote employment in agriculture. To keep rice prices low, the government shouldered expensive subsidies for such inputs as fertilizer and fuel. These subsidies now are a major burden for the government, but they form the basis of a critical economic safety net. By keeping rice prices low, the government also creates a disincentive to production 18 because farmers' profits are limited by price controls. Although reductions in subsidies should be phased in over time to avoid a political backlash, a program that allows the market gradually to set rice prices will increase farm incomes, creating incentives to expand production, promoting the use of private finance sources, and, in turn, strengthening the banking sector. Greater farm incomes also will serve to reduce the need for expensive subsidies.
REVIVING THE CONFIDENCE OF INDONESIA'S CHINESE COMMUNITY
During the current crisis, Chinese businesses and individual Chinese have been targets of violence in Indonesia. Although there is long-standing racial resentment against them, Indonesia's ethnic Chinese are critical to the functioning of the country's economy. Comprising only 2 percent of the population, the ethnic Chinese control upward of 70 percent of the wealth and are a large part of the country's merchant distribution system. President Habibie has handled the ethnic Chinese issue poorly. On the one hand, he said that he welcomed the return of the Chinese, many of whom fled Indonesia because of the violence directed against them; on the other, President Habibie declared that Indonesia could get by without them. It is important for Indonesia's economic recovery that the government work to regain the trust of the ethnic Chinese. If they are willing to reinvest in Indonesia, international financiers may follow their lead. 19
POLITICAL REFORM
Indonesia's challenge is compounded by the fact that it must overhaul its political system at the same time that it seeks to revive its economy. Since taking power, President Habibie has made progress in advancing political reform, changing the role of the military, and addressing the contentious issue of the status of East Timor. Perhaps most important, he has called for new parliamentary elections to be held in mid-1999. President Habibie also has allowed the formation of new political parties, released some political prisoners, and relaxed press restrictions. The pace of change has been rapid: Already more than 40 political parties have sprung up, and there are predictions that the total could reach 100. Eventually, however, observers expect three or four large groups to emerge: the ruling GOLKAR 20 Party; a new opposition party led by Suharto opponent Megawati Sukarnoputri; a large Islamic-oriented party led by Amien Rais; and perhaps another large Muslim group led by Abdurrahman Wahid, possibly acting in alliance with Megawati Sukarnoputri.
Even the students whose anti-Suharto demonstrations led to the first change of regime in Indonesia in 32 years seem willing to give President Habibie's reforms a chance. Large-scale demonstrations against the regime have ceased while the students assess the new political environment and see just how far the reform process will proceed. Empowered by their street protests this past spring, Indonesian students are likely to become more organized and willing to resume protests should President Habibie stray significantly from the path of reform.
But even though a great deal of progress has been made, Indonesia faces a daunting task as it prepares for next year's elections to Parliament. As the International Republican Institute points out in a review of Indonesia's political reform process,
The tasks necessary to overhaul the entire Indonesian electoral and political system are monumental. Some of the many tasks include the drawing of constituency boundaries, registration of over 100 million voters spread across 12,000 islands, registering as many as 100 new political parties and verifying signatures of millions of party supporters, nationwide civic education on the new electoral system and the organizational and operational development of viable, new political parties. 21
After the mammoth undertaking of electing a new Parliament, a great deal of work will remain. Indonesia's 1945 Constitution needs to be revised and updated to legalize political parties, regularize the President's term of office, perhaps institute a more federal system of government that would allocate enhanced power to provincial and local governments, and address the special status of the military in Indonesian society.
Previously the key pillar of President Suharto's rule, Indonesia's military, usually called the ABRI, 22 is evolving toward greater civilian control. President Suharto's son-in-law, the former commander of an elite special forces unit and once one of the country's most powerful military leaders, currently is under investigation in connection with the disappearances of political activists in the months leading up to President Suharto's resignation. ABRI leader General Wiranto is removing from key military positions many supporters of the former President. 23 Many observers expect that the formal role of the ABRI in the government will be diminished, although any such attempt may prove controversial. Although the high command is moderately supportive of efforts to redefine the role of the ABRI in Indonesian society, there is the good chance that other military leaders will be reluctant to cede too much of its power and position.
President Habibie has offered wide-ranging negotiations toward an autonomy plan for East Timor, which Indonesia annexed in 1976. The government has been accused of numerous human rights abuses in East Timor, a largely Christian enclave that was a colony of Portugal. Although Jakarta did develop East Timor economically, there has been considerable internal opposition to Indonesian rule, including armed resistance. Portugal and other states have led international opposition to Indonesia's annexation. Even though Jakarta opposes complete independence--long sought by opponents to Indonesian rule--President Habibie appears ready to allow local rule except in the areas of foreign policy, external defense, and monetary and fiscal policy. 24 In a show of good faith, President Habibie withdrew 1,000 troops from East Timor in late July and early August. There are fears, however, that too rapid a government withdrawal from East Timor could lead to violence among competing factions. 25
AN IMPORTANT FRIEND TO THE UNITED STATES
The United States has a significant interest in an economically prosperous, politically stable, and democratic Indonesia. Indonesia was the 23rd largest trading partner of the United States in 1997. It purchased more than $4.5 billion in U.S. exports last year, in the process supporting more than 60,000 American jobs. Helping Indonesia's economic recovery also will revive U.S.-Indonesia trade, which will decline precipitously this year. Helping Indonesia's recovery also could assist broader economic recovery in Asia, which is in the interest of the United States as well. There are estimates that the economic downturn in Asia will have a negative effect on the U.S. economy. According to William W. Beach, John M. Olin Senior Fellow in Economics and director of The Heritage Foundation's Center for Data Analysis, Asia's economic crisis could lead to a $120 billion loss in U.S. gross domestic product by the end of 1999. 26 This means fewer U.S. exports and over 1 million fewer U.S. jobs. 27
Indonesia is important as well to the security of the United States. Indonesia sits astride strategic sea lanes connecting the Indian and Pacific Oceans through which passes 40 percent of the world's shipping, including 80 percent of Japan's oil supply and 70 percent of South Korea's. Indonesia has been suspicious of China's intentions in the region and has worked within ASEAN to convince China to modify its claims to most of the South China Sea. In recent years, the United States and Indonesia have affirmed their interest in regional security by engaging in military exercises, some in Australia. And, as the world's largest Muslim state, Indonesia has been a welcome moderating force in the Islamic world.
The United States should champion reforms that revive Indonesia's economy and encourage its transition to a democratic political system. To facilitate these changes more effectively, the United States should:
• Invite Indonesia's President to Washington after more progress has been made toward political reform. The United States should send a clear message to the Indonesian people that Americans support their desire for democratic and economic reform. After Indonesia has completed such planned reforms as a new political party or election law, possibly by the end of the year, the Clinton Administration should invite President Habibie to visit Washington. Such a visit could help to provide a much-needed boost to confidence; it also would offer U.S. officials the opportunity to encourage President Habibie to continue economic and political reforms--which are needed much more in order to rebuild foreign investor and broader economic confidence in Indonesia.
• Accelerate delivery of humanitarian food aid while pressing Indonesia to free its agricultural markets. The Clinton Administration's commitment of up to 1.5 million tons of wheat and 50,000 tons of rice was a good first step. The delivery of this food aid should be stepped up, however, to ensure that it reaches Indonesia before expected shortages become acute later this year or early next year. Providing such aid is a relatively easy way for the United States to develop good will with the Indonesian people and help Indonesia to alleviate tensions that could lead to renewed political unrest. Along with this food aid, the United States should urge Indonesia over time to introduce market forces into its agricultural sector, such as decontrolling rice prices. Even though this could cause farm prices to rise, affecting consumers, it also would give incentives to farmers to plant more, which could prevent future shortages.
• Urge Indonesia to increase economic and legal transparency. Greater transparency in Indonesia's economy potentially could have prevented the spread of the financial crisis to Indonesia in the first place. If attention had been called sooner to the increasingly vulnerable international borrowing positions of Indonesian businesses, the effects of the crisis could have been mitigated, at the very least. To enhance transparency, the United States should urge Indonesia to adopt Generally Accepted Accounting Principles and financial disclosure statements comparable to U.S. standards. It is especially important that Indonesia adopt these more stringent standards as it attempts to regain international confidence in the wake of its long history of corruption and favoritism associated with "crony capitalism." It is critical, too, that Indonesia institute and enforce laws that prevent monopoly domination of specific areas of economic activity by single companies or groups. Of course, reform of the legal system, to include rooting out corruption and creating a truly independent judiciary, is the foundation on which every other reform--economic, political, or social--will be built.
• Urge Indonesia to open its banking system to fuller disclosure and to strengthen prudential supervision. Because many banks were in a precarious financial condition even before the crisis began, it stands to reason that fuller disclosure in the banking sector also could have mitigated or headed off entirely the effects of the crisis. Enhanced disclosure would minimize the likelihood of debilitating system-wide runs on banks by helping the public to discriminate between solvent and insolvent banks. But increased disclosure in and of itself is not sufficient: Indonesia's history of corruption and favoritism makes it imperative that regulatory officials examine the books of banks and other financial services firms regularly to identify fraud, self-dealing, and risk-management problems before they grow so large as to threaten insolvency. Increased disclosure and supervision could have the effect of aggravating the banking crisis in the short term, as the true financial condition of poorly run banks is revealed, but these measures are essential to creating the financial superstructure on which future growth can occur.
• Offer the benefit of U.S. experience in liquidating insolvent banks. The U.S. savings and loan crisis of the 1980s generated a wealth of experience in dealing with the types of issues currently confronting Indonesia. As it struggles to increase the degree of transparency in its economy, Indonesia could benefit from U.S. banking and financial regulatory experience. Indonesia should take advantage of the experience of the United States in these areas to avoid errors and pitfalls that could deepen the crisis and prolong recovery.
• Urge Indonesia to remove barriers to trade and investment. Indonesia is in desperate need of trade and investment as it struggles to emerge from its economic morass. Increased hard currency earnings from these activities could mean the difference between continued paralysis and economic recovery. Therefore, Indonesia should remove, to the maximum extent possible, such restrictions on foreign trade and investment as tariffs, quotas, export taxes, nontariff barriers, and prohibitions against foreign ownership or investment. The United States should praise Indonesia's commitment to lower tariffs as part of the ASEAN Free Trade Area and urge Indonesia to fulfill scheduled tariff reductions by 2003.
• Offer Indonesia the benefit of U.S. experience in building democracy. New political parties are springing up daily in Indonesia, but they all lack experience in the functioning of a genuine democratic political systems due to the severe restrictions on political activity of the Suharto era. The National Endowment for Democracy should provide such American organizations as the International Republican Institute and the National Democratic Institute to help teach new Indonesian parties democratic skills. These and other organizations with electoral experience and expertise also could offer to serve as election monitors to assure that next year's elections to Parliament are free and fair.
• Promote reforms in Indonesia's military and rebuild U.S.-Indonesia military ties. Considering the important role of the military in Indonesian society, the United States should build good relations with the ABRI and, where appropriate, promote greater professionalism and evolution toward civilian control. It should urge Indonesia's government to investigate past military abuses, especially in East Timor and during unrest earlier this year. In addition, the United States should not cooperate or conduct exercises with the Indonesian special forces units suspected of conducting these abuses. It should cooperate, however, with less political branches of Indonesia's military, like the air force and the navy. The United States also should praise Indonesian efforts to place the military under greater civilian control. One way to promote military reform would be the restoration of the U.S. International Military Education and Training program with Indonesia. This program allows foreign military officers to study in the United States and witness firsthand the relationship between the U.S. military and civil society. President Suharto suspended Indonesian participation in this program in June 1997 because of U.S. congressional criticisms of human rights abuses in East Timor. Both the Clinton Administration and Congress should make clear their interest in resuming this program.
CONCLUSION
Indonesia's present economic and political crisis presents a key challenge to U.S. leadership in Asia. Indonesia has been devastated by an economic crisis comparable to the U.S. Great Depression. At the same time, Indonesia is beginning a political reform process that many Indonesians hope will reverse the effects of years of strict political authoritarianism and economic autocracy. By offering targeted assistance, the United States can help Indonesians to emerge from their crisis and perhaps to build the world's third-largest democracy. By helping in Indonesia's economic recovery, the United States can lessen the impact of Asia's economic crisis on the U.S. economy. Although offering humanitarian food assistance and necessary economic advice to prevent a second Indonesian political crisis, the United States also should encourage Indonesians to consolidate free-market economic reforms that promote transparency in the financial sector and reduce the government's role in the economy. The United States also can offer advice to help new political parties to learn democratic skills. Just as important, it should rebuild ties to Indonesia's military as it promotes reform in that institution.
Just as Indonesia's economic crisis has caused tremendous suffering, it also has presented the prospect of a far better economic and political order. Indonesia has tremendous potential in its resources, educated workforce, and large consumer market. As a strategically located country with the world's fourth-largest population, an economically reformed and democratic Indonesia would be a worthy strategic partner of the United States in East Asia.
-- John T. Dori is a former Research Associate in The Asian Studies Center at The Heritage Foundation.

REVISED IMF PROGRAM FOR INDONESIA
June 24, 1998
FISCAL POLICY
• To quicken the drive toward increased government transparency, provisions of the Non-tax Revenue Law of May 1997 were accelerated to require all off-budget funds to be incorporated in budget within three years (instead of five years).
MONETARY AND BANKING POLICY
• The minimum capital requirements for existing banks were reduced.
• All restrictions on bank lending were eliminated except for prudential reasons or to support cooperatives or small-scale enterprises.
FINANCIAL SERVICES SECTOR
• An independent review committee was established to enhance the transparency and credibility of the Indonesian Banks Restructuring Agency's (IBRA) operations. Also, it was announced that the issuance of a presidential decree was expected by mid-July 1998 to provide appropriate legal powers to IBRA, including its asset management unit. Plans were to be prepared for the sale of at least one-quarter of IBRA banks in 1999. And it was announced that IBRA will continue to take control of or freeze additional banks that fail to meet liquidity or solvency criteria.
• Six private banks were declared insolvent and their shareholder equity written down. A plan was to be announced for restructuring state banks through mergers, transfers of assets and liabilities, or recapitalization prior to privatization.
• All banks were to undergo financial reviews by internationally recognized audit firms.
• A draft law institutionalizing the autonomy of the Bank of Indonesia (BI), the Indonesian central bank, was to be submitted to the Parliament. Also, BI credits to public agencies and public sector enterprises were to be limited and phased out. Additionally, BI's bank supervision department was to be strengthened so as to strengthen enforcement of regulations. And a program was to be established for divestiture of BI's interests in private banks.
• A deposit insurance plan was to be introduced.
PRIVATIZATION
• Forest concessions were to be auctioned and concession periods lengthened.
• A draft amendment to the banking law, incorporating procedures for the privatization of state banks, was to be submitted to Parliament.
• A clear framework for the reform of all 164 state enterprises, including privatization and restructuring, was to be established. A plan was to be developed for closing nonviable public enterprises.
• Initial sales of additional shares of listed state enterprises, including the domestic and international telecom corporations, were to begin after mid-July 1998.
TRADE AND INVESTMENT LIBERALIZATION AND COMPETITION POLICY
• The list of activities closed to foreign investors was to be revised and shortened.
• Submissions to Parliament were to propose eliminating restrictions on foreign investments in listed banks and removing limits on private ownership of banks.
• Quotas limiting the sale of livestock were to be abolished.
• A draft law on competition to prevent the abuse of dominant position and practices that restrict or distort free competition was to be submitted to Parliament.
• Nonviable public enterprises were to be audited.
• All export restrictions were to be eliminated. Remaining import restrictions and other non-tariff barriers were to be phased out, as was the local content program for motor vehicles. Tariffs on non-food agricultural products were to be gradually reduced to a maximum of ten percent.
Endnotes
1. By comparison, during the Great Depression, the U.S. economy contracted 25 percent over four years.
2. Robin Wright, "Indonesia Facing Economic Meltdown, Experts Warn," The Los Angeles Times, July 31, 1998, p. A1.
3. A consistent hallmark of the various IMF stabilization agreements with Indonesia has been the insistence on keeping interest rates high in an attempt to attract investment and restore the value of the rupiah. The actual effect, however, has been to choke off economic activity because interest rates were set prohibitively high, with attendant negative consequences for investment.
4. Bernard Estrade, "Spectre of Famine Haunts Suharto Regime," Agence France Presse, February 24, 1998.
5. "Rice Shortage May Reach 10 Million Tons; Scientist," Jakarta Post, July 24, 1998.
6. For an overview of the strengths and weaknesses of Indonesia's new bankruptcy law, see Frank Taira Supit, "Indonesia's Phoenix?" Far Eastern Economic Review, July 9, 1998, p. 26. Supit argues that, even though severe deficiencies exist with the new procedures, they will prove ultimately to be a positive force for Indonesia's economy by promoting entrepreneurship and preventing the recurrence of "past excesses."
7. "Main Points of Donors Statement on Aid for Indonesia," Agence France Presse, July 30, 1998.
8. Marcus W. Brauchli, "Why the World Bank Failed to Anticipate Indonesia's Deep Crisis," The Wall Street Journal, July 16, 1998, p. A1.
9. Keith B. Richburg, "Cashing in on Years in Power; Billions Flowed to 'Suharto, Inc.,'" The Washington Post, May 22, 1998, p. A40.
10. "Bank of Indonesia to Be Led by Board of Governors," Asia Pulse, July 31, 1998.
11. Margot Cohen, "Reforming the little Suhartos," Far Eastern Economic Review, July 8, 1998, p. A13.
12. "Law Experts Pessimistic About Legal Reform," Jakarta Post, July 15, 1998.
13. "Amien Sets Out His Agenda for Total Reform," Jakarta Post, July 1, 1998.
14. "Better Salary Key to Boosting Judges' Integrity and Quality," Jakarta Post, May 4, 1998.
15. United States Trade Representative, 1998 National Trade Estimate Report on Foreign Trade Barriers, Washington, D.C., 1998, p. 176.
16. "WTO Ruling Has No Effect on Timor Car, Analysts Say," Jakarta Post, March 28, 1998.
17. Central Intelligence Agency, The World Fact Book, 1997-98, p. 233.
18. "Agriculture Needs Market-Oriented Policy," Jakarta Post, June 9, 1998.
19. Wealthy Chinese that could help Indonesia are angry. On July 28, Wang You-theng, chairman of the General Chamber of Commerce of the Republic of China, called for a suspension of Taiwanese investment in Indonesia to protest violence against ethnic Chinese. For a sober and enlightening assessment of the future role of ethnic Chinese in Indonesian society, see Jusuf Wanandi, "The Road Ahead," Far Eastern Economic Review, July 30, 1998, p. 35.
20. GOLKAR is an abbreviation for Golongan Karya, which means, literally, "Functional Group."
21. International Republican Institute, "Indonesia Political Situation Update," July 15, 1998.
22. ABRI is the commonly used acronym for Angkatan Bersenjata Republik Indonesia, which translates to "Armed Forces of the Republic of Indonesia."
23. "Army Purge," Far Eastern Economic Review, June 18, 1998, p. 8.
24. Portugal and the United Nations have been working with Indonesia to promote an autonomy arrangement for East Timor. See, for example, John M. Goshko, "Progress Made in East Timor Dispute; Indonesia, Portugal Pledge to Pursue 'Wide-Ranging Autonomy' for Territory," The Washington Post, August 6, 1998, p. A22.
25. Jose Manuel Tesoro, "A Legacy of Bitterness," Asiaweek, August 7, 1998, p. 32.
26. William W. Beach, "What a Worsening of the Asian Crisis Might Mean for U.S. Economic Performance," charts distributed at an Asian Studies Center symposium on the East Asian economic crisis held at The Heritage Foundation on July 13, 1998.
27. Ibid.





























Crisis in Indonesia: Economy, Society and Politics
Dr Stephen Sherlock
Foreign Affairs, Defence and Trade Group
8 April 1998
Contents
Major Issues Summary
Introduction
Indonesia's Economic Crisis
Origins of the Crisis
The Crisis Hits Indonesia
The Government's Response-Reform and the IMF
Social Effects of the Crisis
Inflation and Food Shortages
Job Losses, Unemployment and Underemployment
An End to Affluence, a Return to Poverty
The Politics of Crisis-President Soeharto and the New Order
President Soeharto and the Army
The Vice-President and the Army
Change from Below: A People's Power Movement?
The Implications for Australia
From Weakness to Strength: Indonesia-Australia Relations
Australia and the Region
Australia's Response
Conclusion
Endnotes
Appendix: Australia's Trade with Indonesia

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 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 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 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. 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 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 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 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 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 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 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 Indonesia had finally overcome its long history of economic and political instability and was set on a long-term path to prosperity.
The Politics of Crisis-President Soeharto and the New Order
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 class and working class. The apparent end to this success will have grave implications for the political stability of the entire Indonesian state. But even before the onset of the economic crisis, serious pressures were beginning to build up within Indonesia about the lack of progress towards political liberalisation. Many Indonesians were beginning to argue for the development of institutions which might overcome the domination of political life by a small elite around the President and the Army and allow greater mass political participation.
From its very foundation in 1965-66, the New Order has depended for its stability on the leadership of President Soeharto. Soeharto's tenacious grip on the presidency has come to symbolise the personalised nature of New Order politics and the difficulty the regime appears to have in adapting to the changing face of Indonesian society. Paradoxically, the pressure for change has been created by the very success of the New Order in bringing about three decades of economic growth. This development has transformed Indonesia from a country with a tiny social elite and a mass of impoverished peasants to a rapidly urbanising society with new social groups who are gradually becoming less willing to trade political rights for personal prosperity. There is growing resentment about corruption in public life and the domination of economic opportunities by a select few. This is particularly directed against members of President Soeharto's family, most of whom have gained tremendous private wealth from their family connections. With the elevation of the President's daughter to the Cabinet, they appear to be provided with privileged access to political power as well.
There is also a feeling of exasperation that not only does the ageing President Soeharto show no sign of retiring from his post, but he is also unwilling to even discuss the issue of his successor or how a transition of power might take place. Despite the clear current of subterranean discontent, however, there is little indication of moves within elite elements of Indonesian society to remove President Soeharto or to press strongly for reform. The beginnings of unrest in the streets and universities of major cities and regional towns have yet to gain sufficient momentum to be anything resembling a significant challenge to the Government.
President Soeharto and the Army
Given the crucial role of the Armed Forces of Indonesia (ABRI) as the bulwark of the New Order, much recent commentary has focused on the possible actions of ABRI leaders as agents for political change, either to persuade Soeharto to step down or to oust him from power. It is unlikely, however, that ABRI officers would move against Soeharto unless the economic or political situation were to deteriorate drastically. While most observers consider that most of the ABRI leadership think it is time for Soeharto to step down, they are reluctant to express such a view publicly because of their immense respect for Soeharto's achievements as President and because of their close personal relations with him. Members of the current generation of ABRI leaders were trained and rose to prominence under Soeharto and are personally indebted to his patronage. The recently appointed Chief of the Armed Forces, General Wiranto, was a personal adjutant to President Soeharto and rose from the rank of colonel to four-star general in four years. Soeharto's son-in-law, Prabowo, was appointed commander of the elite Strategic Reserve.
Although there have been periods of disagreement between Soeharto and the Army, notably during the late 1980s and early 1990s, Soeharto has since used his power to appoint ABRI officers to ensure that his own supporters hold the key positions. This prerogative was exercised again in February 1998 when he reshuffled the ABRI leadership to strengthen his closest associates. Soeharto has also skilfully manipulated rivalries amongst the top leaders, creating such factional enmities that it would appear to be difficult for many leading ABRI officers to cooperate with each other in any move against the President.(18) In any case, recent thinking amongst many ABRI officers has been influenced by the idea that the Armed Forces should play a less political role and be restructured for external security rather than its traditional role in policing internal stability. Moreover, there is little sign that ABRI leaders have alternatives to the policies being pursued by the President. Most would also be aware that any move by the Army against Soeharto would only weaken international confidence in the Indonesian economy still further.
The Vice-President and the Army
There was widespread concern amongst observers in the international financial community when one of Soeharto's closest confidantes, B. J. Habibie, was made Vice-President. As one of the leading figures associated with the economic nationalist faction of Soeharto's advisers, known for their sponsorship of prestige high-technology projects of questionable economic benefit, Habibie's appointment was interpreted as a sign of Soeharto's unwillingness to reform and regularise Indonesia's economy. But there was also consternation about the appointment within the ranks of ABRI because, according to the Constitution, Habibie would take over as President in the event of Soeharto's death. Habibie's appointment was symptomatic of the relative decline of ABRI influence compared with the situation in 1993 when the Army, against Soeharto's wishes, was able to have its candidate for Vice-President, General Tri Sutrisno, appointed to the office.
Habibie is unpopular amongst the ABRI leadership because he is a rival from a technocratic rather than a military background and because of his sponsorship of the Association of Muslim Intellectuals (ICMI) which, as a mass organisation, gives Habibie a potential political base outside of Army control. ABRI has long been highly suspicious of any mass organisation and ICMI is particularly suspect in ABRI eyes because of its Islamic character. Habibie has also earnt the resentment of many ABRI officers because his organisations have moved into traditional areas of ABRI influence such as defence equipment procurement. Habibie was the main supporter of the purchase of a number of vessels of the former East German navy which most defence professionals considered were inappropriate for Indonesia's strategic requirements.
ABRI's loyalty to Soeharto has ensured that no public criticism of Habibie's appointment has been aired, but it is an open question whether the ABRI leadership would countenance Habibie's assumption of the office of President should Soeharto die or be forced to retire due to ill-health. The possibility that a key institution such as the Army might not accept the person who, in constitutional terms at least, seems most likely to succeed Soeharto underscores the seriousness of the uncertainty surrounding the transition from Soeharto's rule.
Change from Below: A People's Power Movement?
The New Order was born out of the bloody suppression of mass politics, with the killing of an estimated 500 000 people, mostly supporters of the then-powerful Communist Party.(19) Since that time, any expression of popular political will outside officially-sanctioned channels has been vigorously repressed. The dominance of official politics has been challenged on a few occasions, during student riots in 1974, Muslim riots in Jakarta in 1984, workers' riots in Sumatra in 1984 and by the clashes which followed the takeover of the headquarters of the Indonesian Democratic Party (PDI) in July 1996, but these never amounted to a real challenge to the status quo. Similarly, regional secessionist movements in East Timor, Aceh and Irian Jaya have been largely contained. There have been periods during which the Government appeared to be loosening political control, particularly during the period of 'openness' in the early 1990s, but these have always been followed by a renewed crackdown on free public expression and independent political activity. The closure of the newsmagazine,Tempo, and the ousting of Megawati Sukarnoputri from the leadership of the PDI (one of the three officially-sanctioned parties) in 1996 shattered any illusions that President Soeharto was willing to allow movement towards democratisation. A leading dissident academic, Ikrar Musabhakti, was recently quoted as saying:
Our openness is like a rubber ring. It can be opened quite wide sometimes, but the Government can also close it very quickly if it becomes dangerous.(20)
The current economic crisis and its attendant social effects have, however, raised the possibility that many ordinary Indonesian people may join in spontaneous or organised movements of protest which turn out to have a major impact on the course of Indonesian politics. There have been riots in a number of regional towns in Indonesia, particularly in the period following the major price increases of January 1998. Many of these riots were directed against ethnic Chinese-owned businesses. Ethnic Chinese make up less than 3 per cent of Indonesia's population, but are said to control 70 per cent of private business activity.(21) Tight control by ABRI in large urban areas has, however, kept the riots limited in extent. There have also been a number of apparently middle class protests in cities such as Jakarta, but these have also been easily contained by the security apparatus.(22)
It could be argued that the most important development has been the rise of student demonstrations calling for democratisation and the end of President Soeharto's rule. To date, however, riot police have prevented the students from taking extending their movement outside the campuses or from joining together with protests organised by middle class or labour organisations. Nevertheless, the situation on many campuses remains volatile and recent reports of the disappearance of students after being beaten and arrested by police can only serve to intensify feelings. An increase in reports of human rights abuses will also focus international criticism on the Indonesian Government.(23)
There may be limits to the extent to which the security forces are able (or willing) to maintain control over popular protest, especially if the economic situation continues to deteriorate. Urbanisation and other changes in Indonesian society have meant that there are now many more people who could be drawn into a mass movement than might have been the case even a decade ago. Recent years have seen the growth of a large number of non-government organisations (NGOs) committed to social and political change and the emergence of independent labour unions and farmers' organisations. Many middle class people have also been drawn into mass Islamic cultural organisations such as Nahdlatul Ulama (NU) and Muhammadhiya. Megawati Sukarnoputri (daughter of the famed leader of the Indonesian independence movement, Sukarno) has, since her ouster from the PDI, arisen as something of a symbol of opposition to what many see as a repressive system.
Some analysts have discussed the possibility of the emergence of some kind of 'people's power' movement in Indonesia, along the lines of the movement responsible for the downfall of President Marcos in the Philippines in 1986. The situation also has parallels with the circumstances prevailing before the overthrow of the Shah of Iran in 1979, in that a development-oriented, economically successful regime created an urbanised, increasingly politicised society which lost patience with its government's capacity to guarantee prosperity or create space for political dissent. One scenario could be a loose alliance between Abdulrahman Wahid (leader of NU), Megawati and Amien Rais (leader of Muhammadhiya) in a campaign to induce Soeharto to step down or for wider political reform. Such a movement would certainly be supported by the NGO sector and independent labour organisations, but NU and Muhammadhiya have traditionally eschewed oppositional politics in favour of religious and social service. Relations between Rais and Wahid have also been strained over a range of differences. Megawati has not yet shown herself to be prepared to lead a major confrontation with the Government. Notwithstanding signs of popular politicisation in recent years, civil society in Indonesia has been stultified for three decades under the New Order and there does not yet appear to be the beginnings of significant organised opposition.
Once again, a great deal will depend on the actions of the Armed Forces. If large scale rioting were to break out in major cities and required a heavy armed response to quell, the prospect of having to shoot people in the streets of Jakarta might cause existing divisions within the ABRI leadership to develop into an open split. The official ABRI position is that it is the protector of the Indonesian state and not any existing government, a doctrine which might make some officers recoil from a violent crackdown if sufficient numbers of Indonesians were to take to the streets. Such an eventuality would precipitate a political crisis threatening the very existence of the New Order. For the moment, however, there are no signs that the current situation has created such pressures within ABRI or that it is having any difficulty in controlling riots or demonstrations. But the fact that such possibilities are even under discussion is an indication of the potential for serious instability and conflict inherent in the situation in Indonesia today.
The Implications for Australia
From Weakness to Strength: Indonesia-Australia Relations
Relations between Australia and Indonesia since the declaration of an independent Indonesian state in 1945 have had a rocky history, with periods of good relations broken by sometimes open animosity. An initial period of warmth prevailed immediately after independence because of the Australian Government's support for Indonesia's independence struggle. The relationship soured following the change of government in Australia in 1949 and reached a low point in the early 1960s over the issue of Indonesia's claim on the Dutch-held western half of the island of New Guinea (now Irian Jaya) and over Indonesia's campaign of 'confrontation' against Malaysia. Until the late 1980s, relations were dominated by political and security issues in Southeast Asia played out against the background of the Cold War. The tension which characterised relations during the rule of Indonesia's first President, Sukarno, disappeared with Soeharto's rise to power, but the relationship was marked by a series of problems. The most prominent of these were associated with the invasion of East Timor in 1975 (especially the killing of five Australia-based journalists) and the negative Indonesian response to aSydney Morning Herald article in 1986 detailing the business affairs of President Soeharto. Popular perceptions reflected the mutual ignorance of two neighbouring but very different societies, with most Indonesians hardly aware of Australia's existence and many Australians regarding Indonesia with fear and suspicion.(24)
Since the late 1980s, however, the efforts of the Australian Government, accompanied by Australia's generally increasing economic involvement in the region have facilitated the broadening and deepening of the Indonesia-Australia relationship. These efforts coincided well with the Indonesian Government's desire to move its foreign relations beyond a predominant focus on ASEAN. The predominance of politico-strategic issues has been replaced by a broader range of trade and investment relations and greater people-to-people links in the form of two-way tourism, Indonesian students in Australia (in 1997 Indonesia was the second-largest source of overseas students) and the slow development of non-official as well as government-sponsored cultural exchange. Australia and Indonesia are now also part of a network of regional relationships through their common membership of organisations such as APEC and the ASEAN Regional Forum.(25)
Until the mid-1980s trade between Australia and Indonesia was insignificant. Since 1985, however, bilateral trade has grown at an average rate of 19 per cent per year and Australia is now Indonesia's sixth largest trading partner and Indonesia is Australia's tenth most important partner. Bilateral trade reached almost $5 billion in 1996. Accumulated Australian investment in Indonesia has been calculated to be in the vicinity of $US6 billion in 1997.(26) The strengthening of the official bilateral relationship was affirmed by the signing of the Timor Gap Treaty in 1995 and the Maritime Boundary Treaty in 1997, a relationship underpinned by regular meetings at ministerial and official level between the two governments. The signing of the Indonesia-Australia Agreement on Security at the end of 1995 formalised the already well-developed defence and security ties between the two countries, although the mixed public reaction to the Agreement symbolised continued popular uneasiness in Australia about Indonesia.(27)
As one of Australia's closest neighbours, the political and economic fate of Indonesia was always going to be of direct relevance for Australia.(28) This underlying reality has become even more obvious, given the rapid expansion in the links between Australia and Indonesia over the last decade. Indonesia's economic problems have meant a sudden drying up of opportunities for the growing number of Australian businesses operating in Indonesia and the growth in trade is likely to slump and may even register an absolute decrease over the next year or so. Inbound tourism has already been affected and the number of Indonesians studying in Australia is certain to decrease. Like the overall effects of the economic crisis in East and Southeast Asia, the impact on Australia's trade in commodities and services and on investment flows with Indonesia is still yet to be quantified.
Australia and the Region
There is no doubt, however, that the Australian Government needs to be concerned about potential dangers in a deepening political crisis in Indonesia. As the largest country in ASEAN, Indonesia is a key strategic player in the region and has been important in developing positions to manage issues amongst the ASEAN countries and in developing a common ASEAN position on relations with China, including reducing tensions over regional territorial disputes involving China. Resolving such issues has been a crucial element in the evolution of security arrangements in the Asia-Pacific since the end of the Cold War.
Political uncertainty in Indonesia, especially if it involved open conflict over the succession from President Soeharto, would throw many of these achievements into doubt. Any perception on the part of the Chinese Government that the Indonesian Government was fostering or allowing animosity towards the ethnic Chinese minority in Indonesia, for example, could adversely affect relations with China. Tensions have emerged between Malaysia and Indonesia over the issue of Indonesian migrant labourers in Malaysia who have come under pressure to leave because of Malaysia's economic problems. There have also been hints of concern from other members of ASEAN over Indonesia's unwillingness to take difficult decisions to reform its economy and thus find a solution to economic problems which threaten to damage the whole region.(29) Invidious comparisons have been made with Malaysia and Thailand's ability to deal with its problems more effectively. There have already been disagreements between the US and Indonesian Governments in recent years over issues of human rights and labour rights and the suppression of political protest in Indonesia is likely to focus greater critical US attention on developments inside Indonesia.
Australia has an interest in minimising such tensions and conflicts because of its general interest in stability in the Asia-Pacific region and because of its direct bilateral relationship with Indonesia. In bilateral terms, of particular concern in press and public perception is the possibility that economic problems in Indonesia might lead to the arrival of Indonesian refugees or illegal migrants on Australia's shores. Any problem of this type is more likely to manifest itself as wealthy ethnic Chinese Indonesians arriving at Perth or Sydney airport than the stereotype of impoverished 'boat people' in Darwin harbour, but given sensitivity on this issue within Australia, the Australian Government will need to monitor the situation closely.
Australia's Response
The Australian Government's response to the Indonesian crisis has been to provide direct emergency assistance to Indonesia and to contribute, both financially and at a policy level, to the IMF program of assistance. Since October 1997, the Government has provided $8.8 million to a number of programs designed to help relieve problems created by the drought, increasing food prices and unemployment, particularly in the worst affected areas of eastern Indonesia. Australian officials and advisers have also been working with Indonesian agencies to develop strategies to create employment in affected areas. In order to provide a 'second line' of financial support for the Indonesian currency should the IMF finance be insufficient to stabilise the rupiah, the Australian Government made available a loan of $US1 billion, as a part of contributions from a number of regional countries totalling $US17 billion.(30) The Government has stated that the loan is conditional on fulfilment of the terms of the IMF reform package.
While supporting the conditions of the IMF package, the Australian Government has taken the view that the implementation of reforms should be spread over a number of years, thus enabling the second postponed tranche of the loan to be delivered with less onerous conditions attached. In March 1998, the Minister for Foreign Affairs, Mr Downer, visited the US and Japan to hold talks with US and Japanese Government representatives and officials of the IMF and World Bank with the objective of helping to facilitate an agreement between the IMF and Indonesia. The US Government took a similar position to Australia (notwithstanding some controversy within Congress) and, despite some opposition reportedly expressed by some countries of the European Union, the IMF Managing Director, Michel Camdessus, has moved towards support for such a position.(31) This has been the basis for the discussions taking place between Indonesia and the IMF at the time of writing. Australia has also been a party to World Bank talks regarding the delivery of humanitarian assistance to Indonesia to help deal with the problem of shortages of food and other essentials in the coming year.(32)
Conclusion
The economic and political crisis in Indonesia had its genesis outside the country and did not at first appear to present major difficulties for a country whose macroeconomic management was reputed to be generally sound. Once the uncertainty about many Asian currencies began to affect Indonesia, however, the major structural problems in the country's financial sector and the real level of its private foreign debt became obvious and took the rupiah to levels far below those of other falling currencies in the region. Although the current exchange rate is generally regarded to vastly exaggerate the real problems of the Indonesian economy, the rupiah has not yet recovered because the Government's response to the crisis has only served to undermine international confidence in the currency. The lack of confidence also reflects deep-seated fears about the political future of Indonesia, with an aging President who insists on retaining power and obstructing political change even while he appears increasingly out of touch with international economic realities and with the feelings of many of his own people.
At the time of writing it now appears that the Indonesian Government and the IMF are inching towards an agreement which would allow the recommencement of a flow of essential financial assistance to the Indonesian economy. Without that assistance Indonesia would be unlikely to be able to stabilise its currency, which is essential as the first step to restoring the viability of its financial sector and returning Indonesian companies to solvency. Only then will Indonesia be able to take advantage of the opportunities offered by a devalued but stable currency in terms of improved export competitiveness and attractiveness to foreign investors.
In the meantime, however, the social effects of the crisis continue to bite into the living standards of the Indonesian people, with millions of people losing their jobs and every Indonesian suffering as a result of the spiralling cost of basic consumer items. Estimates of the numbers of people being thrown back below the poverty line represent a tragic reversal of the steady progress which Indonesia had been making over the last decades in liberating its people from generations of poverty. The worsening effects of the crisis on the daily lives of ordinary Indonesians threatens to bring the already growing political dissatisfaction amongst many people into the open, whatever their fears about Army repression.
The New Order has prevailed for thirty years because it brought prosperity to most Indonesians, while relying on ABRI to suppress any voices of dissent. In doing so it both heightened expectations and fostered resentment because economic development was matched by political liberalisation. The current crisis has shattered expectations and brought to the surface subterranean discontent which has long been felt about President Soeharto's blatant favouritism and his refusal to allow any public criticism or protest. The transformation of Indonesian society brought about by the New Order has created new potential players clamouring for a say about the new political realities of Indonesia. There are also millions of jobless and underemployed people in the cities and towns of Indonesia. Despite the absence of any obvious individual or movement to lead them today, it is not inconceivable that they might join into a mass movement that, as in the Philippines in 1986 or in Iran in 1979, brings down a governing order.
Endnotes
1. Phil Hanratty,Economic and Financial Turmoil in South-East Asia: Origins and Consequences, Parliamentary Library Information and Research Services, Current Issues Brief No. 8, 1997-98.
2. Leif Roderick Rosenberger, 'Southeast Asia's Currency Crisis: A Diagnosis and Prescription',Contemporary Southeast Asia, vol. 19, no. 3, December 1997, p. 225.
3. ibid., pp. 225-26.
4. ibid., pp. 228-232
5. ibid., pp. 236-38.
6. Oxford Analytica Daily Brief, 28 November 1997.
7. Economist Intelligence Unit,Indonesia Country Report, 3rd Quarter 1997, pp.22-23.
8. Ibid., pp. 19-21.
9. Rosenberger, op. cit., p. 243.
10. Statement by the Managing Director on the IMF Program with Indonesia, International Monetary Fund News Brief No. 98/2, 15 January 1998.
11. Sydney Morning Herald, 8 November 1997, Oxford Analytica Daily Brief, 28 November 1997.
12. International Monetary Fund News Brief No. 98/2, 15 January 1998.
13. Canberra Times, 19 March 1998, p. 7.
14. Asiaweek, 13 March 1998, p.26. Oxford Analytica Daily Brief, 14 January 1998.
15. Oxford Analytica Daily Brief, 14 January 1998.
16. The Australian, 27 March 1998, p. 7.Sydney Morning Herald, 1 April 1998, p. 11.
17. The Australian, 27 March 1998, p. 7. Oxford Analytica Daily Brief, 14 January 1998.
18. I am grateful to Dr Harold Crouch of the Australian National University for much of the analysis in these sections. See Harold Crouch,The Army and Politics in Indonesia, Ithaca, 1978, for a comprehensive study of ABRI's political role. See also Joshua Frydenberg,The Australian, 17 February 1998, p.13.
19. For an account of the violence of 1965-66 see Crouch,op. cit, pp. 221-244.
20. Canberra Times, 1 April 1998, p. 11.
21. Sydney Morning Herald, 21 February 1998, p.38.
22. See for example the report of a protest about price rises by a group called 'The Voice of Concerned Mothers' in Jakarta on 23 February 1998.Canberra Times, 24 February 1998, p.6.
23. Sydney Morning Herald, 6 April 1998, p.8, 7 April 1998, p.8.Canberra Times, 7 April 1998, p.8.
24. For a survey of some Australians' views about Indonesia, see Rob Goodfellow, 'Ignorant and Hostile: Australian Perceptions of Indonesia',Inside Indonesia, September 1993, pp. 4-6.
25. For a survey of Australia-Indonesia relations see B. Bishop & D. McNamara (eds.),The Australia-Asia Survey 1997-98, Melbourne, 1997, pp. 183-211 and Dept of Foreign Affairs and Trade,Country Economic Brief: Indonesia, Canberra, 1997.
26. Dept of Foreign Affairs and Trade,Country Economic Brief: Indonesia, Canberra, 1997.
27. For a discussion of issues surrounding the Security Agreement see Gary Brown, Frank Frost and Stephen Sherlock,The Australia-Indonesia Security Agreement: Issues and Implications, Parliamentary Research Service, Research Paper No. 25, 1995-96.
28. For a discussion of the debate about policy options open to the Australian Government when responding to political conflict and change in Indonesia see Stephen Sherlock,The Politics of Change in Indonesia: Challenges for Australia, Parliamentary Research Service Current Issues Brief No. 3, 1996-97, pp.6-10.
29. Asian Wall Street Journal, 27 February 1998.
30. Data supplied by the Australian Agency for International Development (AusAID).
31. The Australian, 25 March 1998, p. 9.Weekend Australian, 4 April 1998, p.7.
32. Australian Financial Review, 2 April 1998, p. 12.
Appendix: Australia's Trade with Indonesia


















Introduction
Indonesia stands at a crossroads. The economic crisis that began in late 1997 produced a public outcry over corruption and cronyism in President Suharto's government, leading to his resignation and, in October 1999, to Indonesia's first free elections in more than 45 years. The country is now commencing a political transformation, from autocracy to democracy, while at the same time trying to recover from a deep economic recession. The advent of democracy has opened unprecedented possibilities for fundamental change, which introduces substantial risks to Indonesia's social and political stability.
The new President, Abdurrahman Wahid ("Gus Dur"), has named a coalition cabinet that includes a number of leading reformers. The reform agenda seeks to curb corruption, increase competition, promote civilian control of the military and civic reconciliation, and reformulate the balance between central power and local government. But, the Government faces serious challenges in building a democracy and restoring economic growth across an archipelago that includes 350 ethnic groups and 17,500 islands and spans across an area equal to the distance from Oregon to the Bahamas. Indonesia has the opportunity to become a thriving democracy. Growing unrest, and religious and ethnic conflict, however, could lead to a potentially chaotic and bloody breakup of the world's largest Muslim nation. International assistance, particularly well-targeted aid from the United States, can make a critical difference.
Indonesia's importance to the United States and its allies should not be underestimated. Landmark elections have made it the world's third largest democracy. In addition to commanding the Pacific's major trade routes, including the energy lifelines of Japan and Korea, Indonesia is a major supplier of Asia's natural resources and an important emerging market for U.S. trade and development.
The Development Challenge
Indonesia's new government, installed in October 1999, faces enormous political, economic, and social challenges. The new government takes over a country battered by an economic recession that wiped out 15 percent of its gross domestic product (GDP) in a year and hobbled by pervasive corruption that affects everything from major policy decisions to village relationships. It needs to move swiftly to rebuild the economy, resolve social tensions, and strengthen the political institutions that can provide greater transparency and accountability, improve governance, and attack corruption. It needs to restore the confidence of both domestic and foreign investors, increase civilian control of the military, develop processes for reconciling abused and abusers, and institute major constitutional changes that will reform the judicial systems, decentralize power, and increase the authorities of local governments. All this needs to be done while maintaining a social safety net that provides a modicum of social services to a population with growing expectations.
The end of the Suharto era loosed negative as well as positive forces. Long-simmering perceptions of injustice among ethnic, religious and economic groups have flared across the country, raising fears of Indonesia's "Balkanization," particularly following East Timor's overwhelming vote for independence in August 1999. Centrifugal forces have been unleashed in provinces such as Aceh and Papua (Irian Jaya) where rebels have increased their efforts for independence. Violence has erupted in Ambon, Northern Sumatra, East Java, Sulawesi, and West Kalimantan, because of conflicts over land rights, labor issues, migrant workers, resources, and religion, class and ethnicity.
A source of much of the unrest is the historic lack of institutional recourse for violations to personal and property rights. To ameliorate this situation, the government is attempting to reallocate responsibilities and authorities across political levels, decentralize powers to the district level and increase regional autonomy; it is also attempting to reform its justice sector, by improving judicial and prosecutarial capabilities.
Just as justice sector reform is important to assure human rights and access to the political process, it is also critical to providing the environment for economic recovery. Although recent indicators are hopeful, Indonesia still has much work to do to restore its economy to pre-crisis levels. The successful elections of a new government with unquestioned legitimacy and a commitment to reform renewed optimism among potential investors. Growth during the second and third quarters of 1999, the first positive growth since 1997, confirmed hopes that the economy may have bottomed out. Other important macro indicators point to a successful stabilization of the economy--inflation is zero for the year to date, benchmark interest rates are currently at 12-13%, having fallen from a high of more than 70%, and the exchange rate has strengthened.
Despite such positive signs, full recovery remains a distant prospect. The country's external foreign debt (public and private) reached a total of $144 billion as of June 1999, and little progress has been made on restructuring corporate and bank debt. The financial sector remains moribund-no banks are lending. Unemployment remains high and could go higher as restructuring takes hold and corporations cut back. Institutions are still not in place to ensure legal certainty for investors, and disputes over past contracts, particularly in the electricity sector, have cut sharply into the confidence of potential new investors. It appears that the Government has begun to take the necessary steps to get the Indonesian Bank Restructuring Agency (IBRA) to dispose of the non-performing assets which it holds and put performing companies back into private banks.
The economic and political crisis has had a dramatic social impact. Official figures show that the number of individuals living below the poverty line has more than doubled (now 80 million people) since the beginning of the crisis. High inflation and widespread unemployment have reduced the ability of many households to purchase basic medicines and meet minimum nutritional requirements, resulting in an increase in micronutrient deficiencies. The United Nations Children's Fund (UNICEF) confirms that the human cost of the economic crisis has been highest for Indonesia's poorest women and children. The GOI estimates that nearly half of the nation's population is unable to afford adequate food. A contributing factor to the May 1998 riots was the rise in food prices and shortages of staple food items such as rice, cooking oil and sugar.
The rapid decline in household income in combination with declining government resources, specifically for the provision of health services, imperils the health of many Indonesians. The prolonged economic crisis has drastically reduced purchasing power as food prices have skyrocketed, while millions have lost their jobs. As a consequence, many, particularly urban dwellers, cannot afford to purchase adequate food, and the nutrition of mothers and children has suffered. Children are continuing to drop out of school, suggesting that the long-term impact of the crisis may not yet be fully realized. Health care services are less frequently sought, as stretched family budgets go to other priorities. Sexually transmitted diseases are on the rise, as a result of inadequate condom use, delayed treatment, and an increase in prostitution as a source of income.
USAID's Role
The election of a new government in October 1999 opened up a wealth of new opportunities for USAID's FY 2000 program, focusing on supporting the democratic transition, economic reform, natural resource management, health, and humanitarian assistance. USAID is supporting a major, multi-donor effort on justice sector reform as part of a program to build the institutions and processes that will facilitate Indonesia's transition to democracy. It is working with new ministers-and in some cases new ministries, with parliamentarians at the national and local level, with media and with civil society organizations to strengthen legal processes and institutions, providing training and technical assistance to improve access, transparency and accountability. Building on a most successful elections support program, involving more than 200 local and international NGOs, USAID has launched a civic education campaign to encourage accountable government. USAID partners are conducting political party and parliamentarian training-about 85 percent of the 15,000 newly elected parliamentarians have never served in office before-on legislative and constituent representation. They are also providing training to the media in news broadcasting and working with both government and civil society organizations on conflict resolution and reconciliation.
The new decentralization laws-moving toward full implementation in the year 2001-afford new opportunities and risks, as well, that cut across all of USAID's areas of interest-democracy, economic reform, natural resources management, and delivery of health and humanitarian services. USAID is working with local governments now to prepare them for their increased roles under decentralization. USAID consultants are advising on fiscal issues, natural resources management, and on environmental governance, and health advisors are looking at the implications of these laws for health service delivery.
USAID continues assistance to the agencies responsible for corporate and bank restructuring and the ministries involved in trade and competition policy and regulation. There are growing opportunities here as well, as the government begins to establish independent regulatory agencies (competition and anti-corruption are the first) which are in need of donor support. And as part of USAID's work on justice reform, USAID consultants are involved in a variety of programs to strengthen governance and provide investors with greater certainty.
Events in East Timor and unrest in pockets across Indonesia have imposed special burdens on USAID's health and humanitarian assistance program. Through its longstanding partnership with local and international NGOs and with the World Food Program, USAID has been able to target food resources-and continues to do so-to allow Indonesia to deal with the needs of what has become a population of some 700,000 internally displaced people. At least in the near term, until there is greater certainty that social unrest is under control, there will be a need for continued humanitarian aid.
Other Donors
The donor community in Indonesia can be divided into two groups: (1) donors with annual program budgets of $1 billion or more and (2) those with annual budgets of $250 million or less. Multilateral organizations - the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB) and the Islamic Bank - and the Japanese bilateral program constitute the big donors. USAID is the largest contributor in the group of smaller donors, which also includes the European Union, the bilateral programs of Australia, Germany, Britain, France, Italy, the Netherlands, Canada, New Zealand and South Korea, and private U.S., German and Dutch foundations.
The U.S. role as a leading member of the IMF, the World Bank, and Asian Development Bank provides USAID an important opportunity to work closely with multilateral donors on development issues. In addition, as part of the Consultative Group for Indonesia, USAID collaborates with both multilateral and bilateral donors. This collaboration was particularly close in the donor program to support the Indonesian elections in 1999. Despite our level of assistance, USAID's flexibility and country presence provide it a unique opportunity to play a leadership role in donor assistance. USAID has accepted this role most notably in the development of civil society organizations and in its work, as noted above, on democracy and governance, economic reform, natural resources management and health and humanitarian assistance.








Recovery from the Asian Crisis and the Role of the IMF
By IMF Staff
June 2000 Also available:
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I Introduction

II New Breed of Economic Crisis

III The IMF-Supported Programs

IV Structural Reforms Were Essential to the Programs

V Initial Outcomes and Assessment of the IMF-Supported Programs

VI Signs and Substance of Recovery

VII What is Still Required to Maintain Growth with Equity?


Box 1. Thailand

2. Korea

3. Indonesia

4. Malaysia and Philippines


Table 1. Commitments and Disbursements of the International Community in Response to the Asian Crisis


Charts I. Indonesia: Selected Economic Indicators, 1997-2000

II. Korea: Selected Economic Indicators, 1997-2000

III. Malaysia: Selected Economic Indicators, 1997-2000

IV. Philippines: Selected Economic Indicators, 1997-2000

V. Thailand: Selected Economic Indicators, 1997-2000
VI. Selected Asian Countries: Interest Rate and Exchange Rate
Developments

VII. Asian and Tequila Crises




I. Introduction
The financial crises that erupted in Asia beginning in mid-1997 are now behind us and the economies are recovering strongly. This rebound did not happen spontaneously, but came about as a result of steadfast policy implementation by the affected countries and large-scale financial support from the international community, especially under IMF-supported programs for Indonesia, Korea, and Thailand. Economic recovery is also pronounced in Malaysia and the Philippines. While, with the benefit of hindsight, the IMF's policy advice to these countries during the emergency was not flawless, corrections and adjustments to circumstances were made promptly, and the strategies adopted proved successful in restoring financial market confidence and stability, and in achieving a resumption of economic growth, in most cases by late 1998. Sustaining the recovery and making long-term progress in reducing poverty depend critically on the continued maintenance of macroeconomic stability and firm implementation of key structural reforms.
This brief updates the paper entitled "The IMF's Response to the Asian Crisis" that was issued in January 1999. It contains four country boxes (one each on Indonesia, Korea, and Thailand, and a fourth that covers Malaysia and the Philippines), and seven pages of charts, the first five on the individual country cases, and the final two on, respectively, the regional perspective and a comparison of macroeconomic developments during the Asian and Tequila crises.
II. New Breed of Economic Crisis
The crises that began in Thailand with a series of speculative attacks on the baht unfolded after several decades of outstanding economic performance in Asia. Although the circumstances varied among the countries concerned, the difficulties stemmed primarily from a combination of macroeconomic imbalances (even though government budgets were broadly in balance and inflation rates were modest), external developments, and weakness in financial and corporate systems. The external imbalances were a reflection both of strong private capital inflows and of high domestic private investment rates, and were exacerbated, prior to the crisis, by appreciation of the U.S. dollar to which the currencies of the countries concerned were formally or informally pegged.1
The weaknesses of the financial and corporate sectors contained several elements, including pre-existing weaknesses in financial institutions' portfolios; unhedged foreign currency borrowing that exposed domestic entities to significant losses in the event of domestic currency depreciation; excessive reliance on short-term external debt; and risky investments against the backdrop of bubbles in stock and property prices. These elements had been building up in an environment of large private capital inflows and rapid domestic credit expansion in liberated financial systems, where implicit government guarantees (in addition to those entailed in exchange rate pegs) remained pervasive, and supervision and regulation were not up to the challenges of a globalized financial market.
In these circumstances, a change in market sentiment could and did lead into a vicious circle of currency depreciation, insolvency, and capital outflows, which was difficult to stop. Contagion spread rapidly in the region after the devaluation of the baht, as other countries were perceived by investors as facing similar weaknesses that cast doubt on their credit-worthiness. By the time the crises had run their course, a large proportion of the financial institutions and corporations in the affected countries were bankrupt.
III. The IMF-Supported Programs
The IMF was called in to provide financial support for three of the countries most seriously affected by the crisis: Indonesia, Korea, and Thailand. The strategy to address the crisis had three main components:
• Financing. Some US$35 billion of IMF financial support was provided for adjustment and reform programs in Indonesia, Korea, and Thailand, with the assistance for Indonesia being augmented further in 1998-99. Some US$85 billion of financing was committed from other multilateral and bilateral sources, although not all of this financing actually materialized. In addition, concerted action was taken (at different stages after the start of these programs, in different countries) to stem private capital outflows.
• Macroeconomic policies. Monetary policy was tightened (at different stages in different countries) to halt the collapse of the countries' exchange rates--which went well beyond what might have been warranted by fundamentals--and to prevent currency depreciation from leading into a spiral of inflation and continuing depreciation. The monetary tightening was appropriately temporary: once confidence began to recover and market conditions stabilized, interest rates were lowered. Fiscal policy was essentially to be held firm in the case of Indonesia and Korea, while in Thailand a fiscal tightening was planned to reverse an increase of the deficit the year before the crisis.
• Structural reforms. Steps were taken to address the weaknesses in the financial and corporate sectors. Other reforms were intended to alleviate the social consequences of the crisis and set the stage for a resumption of growth.
The macroeconomic projections underlying the initial programs were predicated on the assumption that confidence could be rapidly restored through the presentation of a convincing framework of policies, together with large financing packages. Based on this assumption, growth was projected to slow down but remain positive. The IMF--along with other observers--did not foresee the deep recessions that occurred. In the event, Korea's GDP dropped by 7 percent in 1998, Thailand's by 6 percent, and Indonesia's by 14 percent.
In addition to the financial assistance for programs of policy reform in these three countries, the IMF was engaged with other countries in the region that were coping with the crisis:
• extending and augmenting the existing IMF-supported program for the Philippines in 1997, and arranging a stand-by facility in 1998; and
• intensifying its consultations with other countries affected by the crisis and providing policy advice on steps to help ward off contagion. This included support for the authorities' view in China that its exchange rate against the U.S. dollar should be held stable.
IV. Structural Reforms Were Essential to the Programs
Structural reforms were given more prominence than in typical IMF programs. The details of these reforms were formulated in collaboration with the authorities in each country, as well as the World Bank and Asian Development Bank.
The need for financial sector reform was particularly pressing, given the origins of the crisis. The following essential elements were common to policies in all three countries:
• the closure of insolvent financial institutions, to stem further losses;
• the recapitalization of potentially viable financial institutions, often with government assistance;
• close central bank supervision of weak financial institutions; and
• a strengthening of financial supervision and regulation, to prevent a recurrence of the fragilities that had led to the crisis, the objectives being to restore the health of financial institutions and bring supervision and regulation up to international standards. But in all cases standards were raised gradually, in view of the tradeoff between the need to make a convincing step forward and the concern that raising standards too quickly could shock a system already reeling from the crisis.
The need for corporate debt restructuring, including the establishment of viable workout mechanisms, was also considered to be an essential counterpart to the restoration of the health of the financial system. Here progress was slow in all three countries, with adverse consequences for the pace of economic recovery.
In addition, other reforms included:
• efforts to shield poor and vulnerable sections of society from the worst of the crisis, by deepening and widening social safety nets and (notably in Indonesia) devoting substantial budgetary resources to increasing subsidies on basic commodities such as rice;
• measures to increase transparency in the financial, corporate, and government sectors; and
• steps to improve the efficiency of markets and increase competition.
V. Initial Outcomes and Assessment of the IMF-Supported Programs
The IMF-supported programs were initially less successful than hoped in restoring confidence in all three countries, with capital outflows and currency depreciations continuing after the programs were introduced. This was related to a variety of factors, including:
• initial hesitations and policy reversals in program implementation, such as premature rollbacks of monetary tightening, together with political and electoral uncertainties that cast doubt on prospective policies;
• the overwhelming imbalances between reserves and maturing short-term debt. In Korea and Thailand, investors became even more acutely aware of this as information on the level of usable reserves was revealed in connection with the Fund-supported programs; and
• uncertainties over the official financing packages; in particular, the "second lines of defense" for Korea and Indonesia, announced at the outset of their programs, were not disbursed.
With continued capital outflows and falling exchange rates, the countries experienced much deeper recessions than projected. This reflected mainly a collapse in domestic spending, especially private investment. The countries underwent enormous current account adjustments, associated mainly with sharp drops in imports.
Financial markets stabilized in the early months of 1998 in Korea and Thailand, and significantly later in Indonesia. Exchange rates began to recover, and interest rates had declined to below pre-crisis levels by mid-1998. Economic activity then began to turn around in mid-1998 in Korea and later in the other countries. Once they started, the recoveries were unexpectedly robust, especially in Korea, where growth reached 10.75 percent in 1999 as a whole. The recoveries reflected a resurgence of private domestic demand, the collapse of which had produced the recessions.
The experience of the Asian crisis and the results of the policy strategy stimulated fresh thinking on the international financial system as well as on the appropriate policy response to financial crises. Work is still going on to apply the lessons from the Asian crisis to the IMF's activities. As an early step, the IMF made public in January 1999 a preliminary internal review of the design of, and initial experiences with, Fund-supported programs in Indonesia, Korea, and Thailand.2 This study sought to identify those aspects of the IMF's strategy that had worked as expected, and those that needed to be reconsidered. In September 1999, the IMF published a study reviewing its policy advice to Asia on financial restructuring.3
One of the key lessons, shared by most observers, is the need for stronger efforts at crisis prevention. The course of the crisis clearly showed the difficulty of stopping such developments once they have started. Some lessons in this area include the following:
• the failure of the Fund and most other observers to foresee the crisis except in Thailand underscores the importance of strengthened surveillance, particularly with regard to the vulnerability of the exchange rate and the financial system, so that vulnerabilities can be addressed before they become extreme;
• greater transparency of economic and financial developments, through the publication of economic statistics, including financial and corporate indicators and comprehensive data on official reserve assets and liabilities, is essential to help strengthen establish market discipline, and ensure that asset prices and financial flows adjust less abruptly to adverse information. This also helps avoid the revelation of adverse information during a crisis;
• the crisis raised new questions regarding the appropriate pace and sequencing of capital account liberalization. In particular, it demonstrated the risks of liberalizing the capital account before ensuring the soundness of the domestic financial system. Another sequencing issue is that some countries had liberalized short-term capital flows before liberalizing long-term flows; in particular, the continued regulation of foreign direct investment in some cases promoted a composition of capital flows that heightened vulnerability; and
• there is no evidence that the crisis originated in moral hazard. Mexico's IMF-supported program of 1995, portrayed by some critics as a signal to markets that emerging market countries could count on a bailout from the Fund, in fact had no perceptible effect in Asian financial markets: at that time, investors apparently saw events in Mexico as having no relevance to the Asian tigers.
How are the policy responses to the crisis to be judged?
• tight monetary policies, when firmly applied, did work in reversing exchange rate pressures and preventing inflationary spirals. In Korea and Thailand, the following pattern emerged: after a period of negative real interest rates, currency depreciation, and rising inflation at the outset of the Fund-supported programs, interest rates were raised to high levels in real terms for a few months. Market conditions stabilized, currencies recovered, and interest rates were lowered to below pre-crisis levels; a cycle of inflation and depreciation was thus avoided. Indonesia, in contrast, maintained negative real interest rates through the middle of 1998, with rampant monetary expansion associated with banking collapse and political and social turmoil. The collapse in its currency was much more severe and drawn-out than in the other countries. These experiences cast serious doubt on the claim by some critics that monetary tightening was counterproductive and even accelerated the currency depreciations;
• in hindsight, the programs' initial fiscal objectives, based partly on the assumption (held by most observers at the time) of moderate economic slowdowns, were too tight. They were adjusted, as it became clear that the countries were entering severe contractions, and the collapse in private demand was generating massive current account surpluses. In all three countries, the easing began in early 1998, i.e., only two months after the start of the programs in Indonesia and Korea. In retrospect, this easing should have come earlier, particularly as these countries had entered the crisis with strong fiscal positions and low public debt. While fiscal policy was not a major cause of the recessions, it could have done more to counteract the decline in private demand, which in turn appears to have been driven largely by the balance sheet effects of the crisis itself;
• as noted, structural reforms were clearly needed to restore confidence on a firm basis, by addressing some of the root causes of the crises. But the programs did not initially focus sharply enough on the financial sector and corporate issues; this focus came later, as the linkages were better understood. More generally, the experience raises issues regarding the focus of structural reforms as well as their pace and sequencing. Some of these issues were resolved as the programs unfolded: some reforms were delayed while others, seen as less essential, were winnowed out;
• the experience with financial sector restructuring also highlighted the need for clear government guarantees of bank deposits in the event of a crisis. This figured, in particular, in the closure of 16 banks in Indonesia in November 1997. These banks were deeply insolvent and there is little doubt that they needed to be shut promptly to prevent a hemorrhage of public money to support them. But no announcement was made at the time regarding the treatment of depositors in possible future closures of other banks, which were generally understood to be very likely. This partly reflected concern that a full and well-publicized guarantee could have led to moral hazard. In hindsight, these concerns should have been subordinated to the danger of imminent banking system collapse. Uncertainty regarding the scope of prospective government guarantees appears to have been a major factor accelerating bank runs--until January 1998, when a blanket guarantee of all bank liabilities was announced;
• initially the programs relied mainly on a tightening of monetary conditions and other measures aimed at a restoration of confidence to stem the outflow of private capital. A more heavy-handed approach, possibly involving capital controls, was not pursued partly on the grounds that it could have exacerbated contagion. But as confidence was not restored quickly, concerted private sector involvement (PSI) became necessary in all three countries to stem capital outflows. In Thailand, the authorities reached an early understanding with foreign banks to maintain credit lines to their Thai subsidiaries; Korea's major bank creditors were pressed to keep their money in place in December 1997, a few weeks after the program had begun; and in Indonesia, there was a de facto standstill on corporations' external debt servicing, and later a framework was established for restructuring this debt. This experience raised questions of whether PSI should have been organized sooner--notably in Korea, where a funding crisis loomed a few weeks after the initial program was introduced. The experience also gave impetus to work on establishing modalities for PSI that can be activated in the event of a crisis, but also with a view to underpinning confidence and thus helping forestall crises.
VI. Signs and Substance of Recovery
The economic recovery of most of the crisis countries has been more rapid than anticipated by many observers. The pessimistic scenarios developed during the height of the problems have been avoided. Sound macroeconomic management has been crucial to help strengthen external positions, stabilize financial markets, and facilitate an early return to growth. While the unfinished structural reform agenda in all Asian crisis countries remains large, the efforts of governments to address these difficult issues have contributed to the strong recovery.
• strong real output growth is now occurring in most of the crisis countries, generated by private consumption and exports and some new private investment. In Korea, the economic upturn that began in the last quarter of 1998, less than one year after the darkest days of the crisis, is expected to deliver growth of 8 percent in 2000 and there is upside potential to this forecast. Thailand's economy should grow by 5 per cent this year. In Indonesia, where political turmoil and poor policy implementation impeded recovery, the economy began to grow again in late 1999 and real GDP is expected to increase by 4 percent this year.
• monetary policies in the region remain accommodative, for the most part, in order to underpin economic growth. In many cases, real and nominal money market interest rates are below pre-crisis levels. Interest rates began declining in Korea and Thailand in early 1998 and in Indonesia in mid-1999, as currency pressures eased. However, private sector credit growth in the region remains relatively modest, partly because financial institutions have enhanced their risk-appraisal capabilities and adopted a more cautious approach to new lending.
• fiscal consolidation is occurring gradually as recovery takes hold; budgetary deficits are being eliminated, despite the costs of financial sector reforms, and policies are returning to the principles of minimizing domestic financing and avoiding excessive public debt. While efforts are being made to expand social spending, cuts have been achieved in inefficient infrastructure projects and other unproductive spending, including military appropriations. Steps are being taken to reform tax systems, especially through the removal of tax exemptions to broaden the revenue base and a revamping of the tax administration to increase the efficiency of collection and reduce corruption.
• external current account positions remain in surplus, in part because of competitiveness gains and strong world demand for electronics, which are offsetting increased import demand associated with faster growth. Higher oil prices are tending to reduce trade surpluses in the oil-importing countries of the region, while boosting the trade surpluses of Indonesia and Malaysia. Exchange rates have recovered from their crisis lows but remain well below pre-crisis levels in real effective terms, underpinning competitiveness.
• official international reserves have been rebuilt, making the countries less vulnerable to external shocks. Korea's reserves, which had fallen perilously low in December 1997, had risen to US$85 billion by end-April, 2000, and the country has returned to the international capital markets. In Thailand, international reserves now stand at more than double the stock of outstanding short-term external debt, in sharp contrast to the situation in 1997.
• most regional equity markets have experienced gains since the depths of the crisis, although they remain well below pre-crisis levels in dollar terms.
• the crisis countries have begun to implement important structural reforms: weak banks and other financial institutions have been closed, merged or recapitalized, and supervision has been strengthened; monopolies have been broken up; foreign ownership restrictions have been eased; corporations are being held to higher standards of governance and disclosure; and laws have been passed or amended to strengthen central bank independence, competition policy, bankruptcy procedures, and anticorruption measures.
VII. What is Still Required to Maintain Growth With Equity?
Despite recent achievements, there are continuing concerns as to whether the economic recovery will lead to sustained growth, or whether vulnerabilities may reemerge. While the track record may be better than some critics predicted, structural reforms have not proceeded as rapidly as desired. It is essential to ensure the completion of the large unfinished agenda of structural reforms. This is a major and difficult task, for which political support may not always be forthcoming. It is important to prevent reform fatigue and complacency setting in because of the recent strong economic performance. It remains necessary to:
• accelerate financial sector restructurings. This needs to include finalization of the recapitalization of commercial banks, improved loan recovery, and asset sales. The resulting revenue will help offset the high budgetary cost of restructuring;
• intensify corporate restructuring, focussing on restoring viable corporate balance sheets, both through work-outs with creditors that provide for debt restructuring and operational restructuring to restore competitiveness and profitability. Progress may still prove more difficult than in financial sector rebuilding, partly due to the more limited role of the government; it will, even in the best of circumstances, be a protracted process.
• complete a legal commercial framework for a modern economy, including new laws on bankruptcy and competition policy and the creation of institutions capable of enforcing them, as well as ensuring central bank independence.
• continue the process of market opening and deregulation, including further trade liberalization and simplification of business licensing requirements. These measures are needed to improve the environment for private investment, especially to attract new foreign direct investments and enhance productivity growth.
• extend social safety nets and investment in human capital, helping to preserve social stability through targeted subsidies, education and health programs, and employment creation.
Regional initiatives can also be helpful in supporting sustained economic growth and stable financial relations among participating countries. In this vein, the recent "Chiang Mai Initiative" among ASEAN members and China, Korea, and Japan is an important example of enhanced regional cooperation, through which countries in temporary financial difficulties will be able to obtain foreign exchange from their neighbors through swap and repurchase arrangements. While the details of these facilities still need to be worked out, they should help to complement the work of the IMF and fit well into a strategy of addressing economic issues of the region.
With the above actions in place, and preservation of financial stability through appropriate macroeconomic policies, the Asian crisis countries are likely to emerge stronger than before and fitter for the competitive global environment of the twenty-first century: the countries' economies will be more market-oriented and more transparent; their financial institutions will be stronger and better regulated; their corporate enterprises will be more competitive; and their social safety nets will be substantially improved.
Box 1. Thailand
The Asian crisis first emerged in Thailand in 1997 as the baht came under a series of increasingly serious speculative attacks and markets lost confidence in the economy. On August 20, 1997, the IMF's Executive Board approved financial support for Thailand of up to SDR 2.9 billion, or about US$4 billion, over a 34-month period. The total package of bilateral and multilateral assistance to Thailand came to US$17.2 billion. Thailand drew US$14.1 billion of that amount before announcing in September 1999 that it did not plan to draw on the remaining balances, in light of the improved economic situation.
In the early stages of the program, the Thai authorities adapted monetary policy to a managed float of the baht; fostered the restructuring of distressed financial institutions, including the closure of 56 bankrupt finance companies; enacted budget cuts to free up resources to help finance the restructuring and to support improvement in the current-account position; deepened the role of the private sector in the Thai economy; and sought to attract foreign capital through other reform measures.
The rapid spread of the Asian crisis in late 1997-bringing a larger-than-expected depreciation of the baht, a sharp economic downturn and adverse regional economic developments--warranted revisions to the Thai program. The revisions were undertaken through a series of program reviews conducted in close consultation with the Thai authorities. In the context of a recession, whose severity was unforeseen, they aimed to restore economic growth, ensure the continued restructuring of the Thai economy, and protect those elements of society most vulnerable to the economic downturn.
Monetary policy focused on both supporting exchange-rate stability and fostering an economic recovery. As the baht began to steady, the Thai authorities reduced interest rates. By mid-1998, money market interest rates began to approach pre-crisis levels, and first deposit, and then lending rates, started to drop as well. By September 1999, money market rates reached their lowest levels in over a decade.
Fiscal policy shifted in the face of the economic slowdown. While the first letter of intent called for a government budget surplus equal to 1 percent of GDP in 1997/98, beginning in February 1998 the program began targeting a fiscal deficit. The targeted deficit (excluding interest costs of financial sector reform) grew from 2 percent to 6 percent by April 1999, although the actual deficit for 1998/99 is estimated to have been under 5 percent (inclusive of interest costs of financial sector reform, amounting to almost 2 percent of GDP, the deficit was about 6.5 percent). Much of the increased spending focused on boosting social safety net programs to ensure the protection of Thais affected by crisis. While fiscal stimulus remains important for the time being, over the medium term, fiscal consolidation will be needed to reverse the rise in public debt.
Financial sector restructuring has remained a key policy area throughout the Thai program. In the early stages, the program concentrated on the liquidation of finance companies, government intervention in the weakest banks, and the recapitalization of the banking system. In 1998, the reform effort accelerated, with a focus on privatizing the intervened banks, disposing of assets from the finance companies and restructuring corporate debt. The authorities made great strides by strengthening the institutional framework, including through the reform of the bankruptcy act, foreclosure procedures and foreign investment restrictions. However, non-performing loans remain at a high level, underpinning the need to accelerate corporate debt and bank restructuring.
Thailand's economy returned to positive growth in late 1998, and GDP growth reached over 4 percent in 1999 and should grow by 4.5-5.0 percent in 2000. The balance of payments is expected to remain strong in the near term, even as the current-account surplus declines as the recovery proceeds. Foreign-exchange reserves remain within the $32-34 billion range envisioned in the program. With output recovering and reserves restored to comfortable levels, the authorities treated the IMF loan as precautionary and made no further drawings after September 1999. The stand-by arrangement expired on June 19, 2000.
Selected Economic Indicators
________________________________________
1996 1997 1998 1999* 2000**
________________________________________
(Percent change)
Real GDP Growth 5.9 -1.7 -10.2 4.2 4.5 to 5.0
Consumer prices (period average) 5.9 5.6 8.1 0.3 3.0
(Percent of GDP [minus sign signifies a deficit])
Central government balance*** 1.9 -0.9 -2.4 -2.9 -3.0
Current account balance -6.0 -7.9 -2.0 12.7 9.1
(In billions of U.S. dollars)
External debt 90.5 93.4 86.2 76.0 67.8
________________________________________
Sources: Thai authorities and IMF staff estimates.
*Estimate.
**Projection.
***Fiscal year, which runs from October 1 to September 30.



Box 2. Korea
Over the past several decades, Korea transformed itself into an advanced industrial economy. However, the financial system had been weakened by government interference in the economy and by close linkages between banks and conglomerates. Amid the Asian financial crisis, a loss of market confidence brought the country perilously close to depleting its foreign exchange reserves. On December 4, 1997 the IMF's Executive Board approved financing of up to SDR 15.5 billion or about US$21 billion, over three years.
The objectives of Korea's crisis resolution strategy were, first and foremost, to restore confidence and stabilize financial markets, and second, to lay the foundation for the resumption of sustained recovery in the real economy. The program thus included a mix of macroeconomic policies and far-reaching structural reforms. In addition, Korea reached agreement with foreign banks in early 1998 to extend the maturity of short-term claims on its banks to avoid default.
At the outset of the program, Korea's macroeconomic policies focused on a temporary interest rate hike aimed at stabilizing the won and avoiding a depreciation-inflation spiral. This step helped restore financial stability by early 1998, and once the won was stabilized, macroeconomic policies quickly eased to provide stimulus to the economy. The authorities also adopted an expansionary fiscal stance early in the program to mitigate the impact of the inevitable recession. The government recognized that the smooth implementation of adjustment policies would require broad social consensus and it fashioned a Tripartite Accord involving labor, business, and the government. The authorities also strengthened the social safety net by expanding the unemployment insurance system and providing direct support through public works programs, temporary livelihood protection, and other social programs.
The structural reform agenda focused on liberalizing the capital account, restructuring the financial and corporate sectors, enhancing labor market flexibility, and improving data reporting. Korea's restructuring sought to restore stability to the financial system quickly through liquidity support, a time-bound blanket guarantee, and closures of nonviable institutions. The restructuring effort also aimed at resolving the problem of non-performing loans, recapitalizing banks, and strengthening the institutional framework by bringing prudential regulations and supervision in line with international best practices.
Corporate restructuring efforts initially concentrated on improving governance and competition policies. Subsequently, the focus shifted to financial and operational restructuring, with the goal of reducing debt levels and strengthening capital structure. Progress is being made in the out-of court workout agreements for a number of companies and also in court-supervised insolvencies within the framework of capital structure improvement plans reviewed by banks. In addition, progress is being made in meeting the pledges under these plans; equity issues, spin-offs, asset sales, and strategic alliances with foreign investors account for most of the improvement.
Korea is now recovering strongly and the policies adopted under the IMF-supported program have helped to successfully restore external stability, rebuild reserves, and initiate reform of the financial and corporate sectors. Korea has stopped drawing from the IMF; it also repaid part of the stand-by drawings nine months ahead of schedule. The challenge ahead is to avoid complacency and maintain the momentum of structural reforms.
Selected Economic Indicators
________________________________________
1996 1997 1998 1999* 2000**
________________________________________
(Percent change)
Real GDP Growth 7.1 5.5 -6.7 10.7 8.0
Consumer prices (end of period) 4.9 6.6 4.0 1.4 1.8
(Percent of GDP [minus sign signifies a deficit])
Central government balance 0.0 -1.7 -4.4 -3.5 -3.01
Current account balance -4.4 -1.7 12.7 6.1 2.0
(In billions of US dollars)
External debt 164.4 158.1 148.7 136.0 129.6
(Percent of GDP)
External debt 31.6 33.2 46.9 33.4 26.8
________________________________________
Sources: Korea authorities and IMF staff estimates
* Estimate.
** Projection.
1For 2000, includes civil service pension fund.



Box 3. 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 ($18 billion--the so-called "second line of defense"). Although the rupiah initially appreciated, market sentiment began to sour again in December 1997 - January 1998, after sixteen insolvent banks were closed by Bank Indonesia in November. There were also slippages in program implementation coupled with serious social and political upheaval, which culminated in the fall of President Suharto in May 1998. By end-July 1998, the rupiah had fallen by about 65 percent relative to end-1997. The loss of confidence sparked financial instability, and output collapsed, with a severe impact on the poor.
In August 1998, a strengthened reform agenda was reflected in a new extended arrangement with the Fund. To break inflation, the program was anchored in firm base money control. Food security --especially rice--was gradually restored through emergency imports, a strengthened distribution system, and temporary food subsidies. Banking sector reform accompanied by corporate restructuring, an effective bankruptcy system, deregulation and privatization, and improved governance were also at the core of the program. This policy framework delivered important results, including the virtual elimination of inflation, the stabilization of the rupiah, and a recovery in foreign exchange reserves. Interest rates were brought down dramatically, and rice prices stabilized. Improved market sentiment was reflected in the recovering stock market and in falling risk premia. Nevertheless, the overall progress did not reach a decisive stage under the program. There were lags in implementation of bank and corporate restructuring measures. Continued weakness in the governance of key institutions was exposed in the Bank Bali scandal and, along with other factors, led to the suspension of the IMF program in September 1999.
Against this background of fragile and incomplete accomplishments, the newly elected government negotiated a new three-year extended arrangement for about US$ 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)
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.



Box 4. Malaysia and Philippines
The financial contagion that affected Asian countries from mid-1997 also hit Malaysia and the Philippines, but their experiences were somewhat different from other countries.
Malaysia's macroeconomic conditions were substantially stronger at the outset than those in the other crisis countries, particularly in the areas of external debt, inflation, and savings; the country also had a significant fiscal surplus. Its banking system and corporate sector were healthier that the other affected countries. The Philippines had embarked on a successful IMF-supported program of macroeconomic adjustment and structural reforms in the late 1980's and early 1990's, which seems to have enabled it to weather the crisis at a relatively lower cost in terms of output loss, unemployment and social dislocation. Crisis management after mid-1997 was sound, and the Philippines adapted its policies, including through the floating of the peso, tightening of monetary policy and strengthening of the banking system. It eventually relaxed its fiscal and monetary policies as stabilization took hold in mid-1998.
In both countries, however, the initial manifestations of the crisis were similar to those in Indonesia, Korea and Thailand, including a loss in investor confidence resulting in large capital outflows, a decline in reserves, stock market collapses and large currency depreciations. The policy responses were also similar initially. In particular, Malaysia responded with a tightening of monetary and fiscal conditions, and an emphasis on structural reforms, particularly in financial sector regulations and supervision and improvements in intermediation.
Malaysia imposed capital controls in September 1998, largely aimed at the offshore ringgit market in Singapore and short-term portfolio flows. The offshore market was believed by the authorities to constrain their ability to bring down interest rates rapidly. Controls took the form of requirements to bring the ringgit on-shore by end September, and a one-year holding period for repatriation of portfolio capital inflows. The latter controls were replaced in February 1999 with a system of graduated exit levies, and further relaxed in September 1999.
Malaysia's imposition of capital controls does not appear to have made a substantial difference, either positive or negative, to economic developments so far. The stabilization in the currencies of the region and the relative undervaluation of the ringgit resulting in a large balance of payments surplus have facilitated the implementation of these controls. Potentially negative impacts of controls may have been subdued, given that when they were imposed, most capital flight had already abated, and the acceleration of regional recovery, together with progress in financial and corporate restructuring and generally sound macroeconomic management in Malaysia helped buttress confidence.
In the Philippines, recent macroeconomic developments have also been favorable. Recovery is well under way with real GDP growth of 3.25 percent in 1999, led by a rebound in agricultural production from a severe drought in 1998. Monetary policy is supportive of continued recovery, and interest rates are now below pre-crisis levels, while foreign exchange reserves have risen to the level of short-term debt (on a residual maturity basis) as the current account surplus increased to almost 9 percent of GNP in 1999. Bank balance sheets are also being strengthened. The budget deficit had been allowed to increase to support recovery, but fiscal policy has shifted toward consolidation in 2000 given the need to reduce the relatively high level of public debt.
The authorities of Malaysia and the Philippines are now focussed on implementing structural reforms to address the vulnerabilities and provide the basis for sustained growth over the medium term. Much remains to be done to strengthen both countries' ability to withstand negative external developments and sustain the current economic and financial recovery, and the broad structural reform agenda remains a challenge for the respective authorities.










Table 1. Commitments and Disbursements of the International Community
in Response to the Asian Crisis
(in billion of U.S. dollars)
________________________________________
Commitments
________________________________________ Disbursements
(as of 5/30/00)
________________________________________
IMF Multilateral1 Bilateral Total IMF Other4 Total
________________________________________
Indonesia2 15.0 10.0 24.7 49.7 11.6 10.3 21.9
Korea3 21.1 14.2 23.1 58.4 19.8 10.6 30.4
Thailand 4.0 2.7 10.5 17.2 3.4 10.9 14.3
Total 40.1 26.9 58.3 125.3 34.8 31.8 66.6
________________________________________
1World Bank and ADB
2Includes augmentations since July 1998
3Korea has repaid US$ 13 billion of the financing provided by the IMF as of end-May 2000.
4Combined multilateral and bilateral disbursements







________________________________________
1The origins of the crisis are discussed more fully in the IMF "World Economic Outlook" of December 1997.
2See Timothy Lane and others, "IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment," 1999, IMF Occasional Paper 178.
3See Carl-Johan Lindgren and others, "Financial Sector Crisis and Restructuring: Lessons from Asia," 1999, IMF Occasional Paper 188.