Is there a future for Indonesia without the IMF?

Juergen Kaiser Jubilee.De Dusseldorf Germany

Throughout the month of June Indonesia saw a quite lively debate regarding its future relationship with the IMF. It has been instigated by Planning Minister Kwik Kian Gie and it has ended with the cabinet decision to extend the current arrangement with the IMF for another 12 months till end 2003.

There is good reason to presume that breaking away from the Washington institution has never really been considered by the impressive bunch of hardliners, which has joined into Kwik's rethoric (Vice President Hamzah Haz and People's Assembly chairman Amien Rais). Most probably, Kwik's harsh words were targeted at a domestic audience, which needed to be confirmed that the government of Indonesia was not a puppy of Western interests.

However, the ambiguous character of the maneuver does not invalidate its content, particularly as former co-ordinating minister Kwik knows what he is talking about. So the question he raised, which are definitely worth answering are:

Is the cooperation with the Fund actually benefiting or rather harming Indonesia?

Can there be a future for such a fragile economy as Indonesia's without the inflow of new funds, which can only be mobilized by the Fund, and nobody but the Fund?

At the outbreak of the Asian Crisis Indonesia found itself before the alternative to either let its largely bankrupt banking system go down the drain, or to use public funds to save it.

Counseled by the IMF, the predecessor administrations of President Megawati decided to pile up a huge internal debt of the state, which today amounts to roughly half of GNP in order to recapitalize the actual banking system. The alternative would have been to disrupt a large part of Indonesia's economic activity by accepting the bankruptcies of practically all the major Banks.

Subsequently the same state funds would then have been used to finance a brand new credit industry under the control of the state. Administrations had some reason to fear the consequences of such a disruption and to rather do their utmost to keep the existing system working.

The Indonesian state has had to pay a twofold price for this:

First it has left most of the Soeharto-era structures in the financial web of the country intact. Had the state dared to use the some $60 billion internal bonds to capitalize new institutions which might have taken up the banking function, this would certainly have caused major disruptions in the country's economy. On the other hand it would have given the country a kind of fresh start regarding its financial and entrepreneurial elite - something which is painfully lacking, when nowadays even cabinet ministers lament that the country's bureaucracy is "corrupt to the bones".

Secondly, the recapitalisation of existing banks has maneuvered Indonesia into a kind of debt trap. One of the merits of the debate instigated by Kwik was to have highlighted some of the most malign dimensions of this trap: As the recapitalisation bonds bear interest in the range of 13-14%, they place a heavy burden on the state budget. At the same time it has been an IMF key condition, to privatise the banks and to use the proceeds from these asset sales for closing existing gaps in the current budgets.

This pressure to sell has lowered the assets' value to the extent that in some cases the government can realistically expect to receive less for their assets than what they still owe to the sold institutions in the form of interest on the recap bonds.

Observers consider a recovery rate of some 30% of what the state has actually invested as realistic. This, of course, is not only due to high interest rates but also to the poor quality of the recapitalized banks' assets. A perfect trap so: No (meager) sales - no balanced budget - no new money from the IMF (and other donors) - more budget problems.

While many - including the author - had felt that in 98/99 recapitalizing the banks had been an unpleasant but unavoidable exercise, it now becomes clear that the government has put its head into the noose, which now starts being torn tight. It has been Kwik's merit, and those, who, for whatever reason, have joined him, to at least have cried foul.