Indonesia, Australia and overcoming the Asian crisis
Indonesia, Australia and overcoming the Asian crisis
Former Australian prime minister Paul J. Keating, in his
capacity as visiting professor of public policy, discussed the
impact of the Asian economic crisis on the region in his lecture
at the University of New South Wales in Sydney in March. The
following is a slightly edited version of the lecture. This is
the first of three articles based on the lecture.
SYDNEY: The Asian economic crisis, which began with
speculators' attacks in Thailand in May 1997, is presenting
Australia and the other countries of the region with a complex
and dangerous challenge.
That challenge is not just economic, although the implications
for individual economies, including Australia's, are serious. It
is political and strategic as well.
The whole direction, in which the Asia-Pacific has been moving
-- toward economic and political openness, toward a sense of
Pacific community -- is at risk. It is a perilous moment and
there are real questions in my mind about whether we and our
institutions can meet it successfully.
I want to talk about why the Asian economies suddenly look so
shaky, why the problems seem worse in Indonesia, the country of
greatest immediate concern to Australia, what the implications
are for our global and regional institutions, and what Australia
should be doing about it.
This is the first regionwide crisis we have seen in Asia since
it became one of the central pillars of the global economic
systems.
Its origins will be the stuff of many future Ph.D. theses. And
it will take time to untangle its roots.
No one accurately predicted its timing or its precise cadence.
And no one understands with certainty whether it will spread
further or how long its resolution will take.
But one of the important causes certainly lies in currency
exchange rates and the impact of rapid movements of currency,
which the information revolution has facilitated.
Its beginnings can be traced back to 1985. That was the year
when, in response to growing U.S. concern about the size of its
trade deficit with Japan, the Group of Five (G-5) industrial
countries agreed in the Plaza Accord (in New York) to take
coordinated policy actions to push the U.S. dollar lower. The
result of their efforts, as they intended, was that the yen
appreciated strongly against the U.S. dollar.
That rising yen increased costs for Japanese exporters and
encouraged them to move offshore. Asia was the preferred
destination, in part because the pegs that Asian governments had
established between their currencies and the U.S. dollar made
production costs cheap.
Over the next decade, this link with the dollar served Asian
countries well. It facilitated the long boom in foreign direct
investment into the region, with all the associated benefits,
including technology transfer, which came with it. From the mid-
1980s, Japanese companies built as much manufacturing capacity in
continental Asia as exists in France. Businesses borrowed dollars
cheaply at low rates of interest, thinking that the fixed tie
with the American dollar gave them a natural hedge.
But then the game changed. In the two years after 1995, the
U.S. dollar rose 60 percent against the yen, dragging the pegged
Asian currencies up with it. As these economies became less
competitive, their current accounts were exposed to much greater
scrutiny, especially as regional exports fell after 1996.
The artificiality of the dollar pegs became more obvious and
devaluation became inevitable.
Stephen Grenville, the deputy governor of the Reserve Bank of
Australia, recently described the crucial combination of elements
in the crisis as "the large volatile foreign capital flows, plus
fragile financial sectors" which made these economies very
vulnerable to changes of confidence.
In effect, the pressures of growth had become too great for
the inadequate structures of the Asian countries to cope with.
Their economic systems lacked transparency, banks were often
seriously underregulated, lending was politically directed and
legal structures were inadequate.
The contagion spread with astonishing speed. In the markets,
as Jeffrey Sachs put it, "Euphoris turned to panic without
missing a beat."
The economies of Thailand and South Korea, Malaysia, the
Philippines and Indonesia came under scrutiny, then pressure.
But nowhere has the pressure been more intense than in
Indonesia, and nowhere in Southeast Asia will the consequences be
more serious. The reasons, as should be so, are matters of the
greatest importance to Australia.
I said as prime minister that no country was more important to
Australia than Indonesia. That reality will be brought sharply
home to us over the next 12 months.
Clearly, what happens in Indonesia affects Australia's
prosperity and security directly. We cannot isolate ourselves
from the consequences of large-scale economic, social or
political uncertainty among the 202 million people living on an
archipelago which stretches over 5,000 kilometers across our
north.
But developments in Indonesia affect Australia indirectly as
well because what happens there will determine -- not simply
shape or mold but "determine" -- how quickly and peacefully the
rest of Southeast Asia can develop.
This was a lesson which was clear to us more than 30 years
ago, as Australians and our neighbors in the region watched with
relief the transfer of power from president Sukarno to Gen.
Soeharto and the establishment of the New Order government.
It is important to recall that time. Indonesia's economy was
in chaos, inflation reached 1,000 percent and, as part of its
policy of confrontation against Malaysia, the Indonesian
government had launched attacks on its nearest neighbors.
Australia was directly, if unofficially, involved in that
military conflict.
The consequences of those developments in Indonesia in 1965
and 1966 have shaped Australia's environment for the past 30
years. As I have said before, the coming to power of the New
Order government was the single most beneficial strategic
development for Australia in the post-war years.
In abandoning the dangerous international adventurism of his
predecessor, President Soeharto provided the solid underpinning
for successful regional cooperation through the Association of
Southeast Asian Nations (ASEAN) and later the Asia Pacific
Economic Cooperation (APEC) forum.
He refocused the efforts of the Indonesian government on
economic and social development. The New Order government
delivered consistent economic growth of about 7 percent a year.
And, just as importantly, the growth was spread widely.
According to the World Bank, poverty was reduced more rapidly in
Indonesia than in any other country it has studied.
The social indicators were equally strong. Over the past 25
years, the number of Indonesians living in absolute poverty fell
from 60 percent to 11 percent, infant mortality was halved and
life expectancy rose by 17 years. Literacy rates were up from 39
percent in 1960 to more than 80 percent now. Economic
modernization and family planning successes mean that there are
some 50 million fewer Indonesians than would otherwise have been
the case.
As a result of these developments, Australia was saved
literally billions of dollars in defense expenditure and a market
was created for trade worth A$5 billion last year.
Until this current crisis, Indonesia had been one of Asia's
great success stories. In addition to a high growth rate, its
current account deficit was less than 4 percent, its budget was
in balance and inflation was under 10 percent.
As in Thailand, Indonesia's economic problems began when its
government was unable to sustain its informal currency peg
between the rupiah and the U.S. dollar. Indonesia had benefited
greatly from that peg and the inflow of foreign direct investment
it brought. But one of the consequences of opening up the economy
was to give the financial and currency markets of New York,
London and Frankfurt a significant influence on the Indonesian
economy. I do not think this change was fully understood in
Jakarta.
As the Indonesian economy came under greater scrutiny,
problems that everyone had known about and lived with, like a
weak banking sector, a lack of transparency in the economy and
political direction of investment decisions, were put under the
microscope.
Capital started leaving Indonesia, capital inflow slumped and
confidence evaporated in the local market. The problems were
magnified because an estimated 75 percent of the offshore private
sector debt of about US$74 billion was unhedged.
As the rupiah came under pressure, the Indonesian government
realized it did not have the resources to defend the peg. In
August 1997 -- quite early in the crisis -- it decided to float
the currency.
But neither that action, nor its extensive economic
deregulation package in September, nor an International Monetary
Fund (IMF) package in November, which the Indonesian government
was praised for seeking in a timely way, were sufficient to
restore market confidence.
The annual budget delivered in January had some strong points
but was undermined by out of date economic assumptions,
especially about the value of the currency. The government was
forced back to the IMF to negotiate another, even larger, $43
billion, package of support.
This package, which was signed on Jan. 15, surprised almost
all observers with its comprehensiveness. It involved extensive
economic restructuring, including fundamental reform of the
financial sector and the dismantling of most government
monopolies. "Sweeping away all the restrictions" was the way the
IMF put it.
But despite these measures, the rupiah has not recovered. From
a rate of 2,430 to the U.S. dollar in mid-1997, it has dropped to
a current level of about 8,000. In these circumstances,
Indonesia's high foreign debt of $120 billion becomes an
insupportable burden. In essence, the Indonesian government has
lost control of the pace of its adjustment to the global economy.
To give some idea of what Indonesia has to cope with, the
decline in the rupiah's value is the equivalent of the Australian
dollar falling from 75 cents to 10 cents. No government can cope
with that. The current rate of exchange is quite unreal -- a
fiction which bears no relationship to the strengths of the
Indonesia economy.
As the governor of the Reserve Bank of Australia, Ian
Macfarlane, has pointed out "Falls of this size defy economic
logic and serve no useful economic purpose ... There is no value
to Indonesia, to the region or the world in now having an
exchange rate at a quarter of its former level."
But Indonesia's economic problems are not confined to the
financial sector. In parallel with the currency crisis, the
widespread El Nio drought has brought smaller rice harvest and
food shortages as well as catastrophic forest fires in East
Kalimantan.
This depressed economic outlook and the impact of many of the
IMF reforms will have serious social consequences. These cannot
be avoided.
Fuel subsidies will be out and food will rise in prices. At
the same time, the unemployment results of the currency collapse
will be felt more strongly.
Official estimates, almost certainly too low, are for a 50
percent increase in the number of unemployment to 6.5 million
during the course of the year.
The Indonesian economy is expected to contract by at least 5
percent this year. And inflation is already rising and is
expected to hit 40 percent. Hyperinflation is possible.
These economic problems raise the likelihood of social unrest.
Resentment against Chinese shopkeepers could lead to further
looting and rioting with unforeseeable consequences. The
leadership of the Indonesian Armed Forces is strong and competent
but, in such circumstances, discipline will be tested.
This is not just a matter of foreign policy concern. It is a
human tragedy. The economic decline has dashed the prospects for
tens of millions of ordinary Indonesians, who for the first time
had been seeing some real improvements in their lives and better
hopes for their children.
Why did it happen? Why have markets punished Indonesia so much
more severely than other Asian countries in demonstrably worse
macroeconomic shape?
The main reason is that the future of the Indonesian economy
became caught up in judgments about its political system.
This was partly unfortunate timing. The onset of the crisis
coincided with what was always going to be an uncertain political
period in Indonesia, leading up to the presidential election.
Markets like certainty and the Indonesian political timetable
meant they could not have it.
Aspects of Indonesia's own response to the crisis contributed
to the difficulty. It sent out mixed and sometimes confusing
messages as in the uncertainty about the currency board proposal.
And it has backtracked on some important issues in the agreement
with the IMF (as well as on some trivial issues which had
symbolic importance internationally).
The regrettable truth is that times like this require
directness and clarity rather than Javanese obliqueness.
But most importantly in my opinion, Indonesia was
disproportionately punished because a grossly inaccurate view had
taken hold in some quarters in Europe and North America that it
was some sort of rogue state, to be talked about in the same
breath as Mobutu's Zaire or Marcos' Philippines. Partly as a
result of East Timor and domestic dispute over political fund-
raising in the United States, Indonesia had become a symbol and a
caricature rather than a real, complex and deeply important
country.
Indonesia has not been good at telling its own story. It is
noticeable how few voices exist in the United States or Europe
willing to speak out for Indonesia -- I'm not talking about the
government here but the country and people.
The result was that the international goals for dealing with
the crisis, and the performance measurements against which
Indonesia would be judged, were expanded and restructured to
include, explicitly, wholesale economic and social reform and,
implicitly, a change in the political leadership.
So the IMF's demands included not just measures to allow
orderly economic adjustment but complete reordering of the
Indonesian economy.
It seized the opportunity to try to impose in one sweep an
extensive and intrusive program of change. Some of the reforms it
demanded were badly needed and will greatly strengthen the
Indonesian economy when it recovers. But the fund has made that
recovery more difficult by changing Indonesia's political
dynamics and imposing goals which were politically unachievable,
and therefore' delaying any restoration of confidence.
It is important to remember that despite Indonesia's rapid
growth, it remains a developing economy with serious problems of
administrative efficiency -- just in getting the government's
writ to run, it ought not to be surprising if it has run into
difficulty implementing a complex package of reforms which I
doubt that Australia, with a smaller population and better
communications, could have put in place in two months.
It was noticeable that almost before the ink was dry on the
January agreement, prominent voices in the United States and
Europe were casting doubts on Indonesia's willingness to comply.
This had elements of a self-fulfilling prophecy about it. It
undercut, almost immediately, the very confidence the measures
were designed to restore.
Some of the commentary we are seeing about Indonesia has a
chilling tone to it. Those who argue that the screws should be
tightened on President Soeharto and the government because this
will somehow force political change show tragically little
understanding of what the consequences of widespread unrest in
Indonesia would be for real people in the real world.
The IMF has done its job with good intentions, but I agree
with those who argue it has been the wrong job. Or perhaps the
right job, but in the wrong time and manner.
I am certainly not arguing against further reform. I fully
agree with the need for greater transparency and economic and
political openness. This is a line I have pressed in APEC and
around the region.
The immediate need, however, is to stabilize the rupiah and
get it back to a figure in the vicinity of 5,000 to the U.S.
dollar.
This cannot be done without wholesale reform of the banking
and finance sectors, and the satisfactory rescheduling of
Indonesia's corporate debt. But it does not require the immediate
dismantling of the above monopoly, however worthy a goal that
might be.
The essential requirement is to get confidence back into the
investment community, both domestic and international.
To do this Indonesia has to directly address the question of
the private debt owed to overseas creditors. So long as this
issue is unresolved, solvency will not be restored to the bulk of
the corporate sector and the rupiah will continue to hover at
unrealistically low levels.
In part, this might be done by the large Indonesian companies
converting debt into equity, or at least acknowledging that even
at any reasonable exchange rate, the corporate debt will still be
too high and will require dealing with. A move along these lines
would help confidence in the rupiah.
The new government has already announced plans to restructure
its 164 state-owned companies and has foreshadowed the
development of strategic partnerships with foreign firms. It will
find benefits in moving speedily on this front.
But under the best circumstances imaginable, it will be a
long, tough road to recovery in Indonesia.