Managing Bank Indonesia: An insider's look at the crisis
Vincent Lingga, The Jakarta Post, Jakarta
Mengelola Bank Indonesia Dalam Masa Crisis (Managing Bank Indonesia During the Crisis); By J. Soedradjad Djiwandono; PT Pustaka LP3ES Indonesia, 2001; 398 pp
What was the main cause of Indonesia's economic crisis, which many analysts have described as the most dramatic reversal of fortune the world has seen over the past 50 years?
The crisis was not precipitated entirely by the financial panic in Asia that eventually set off in Indonesia the worst implosion of a financial system seen in the world in recent history. Nor could it be blamed solely on Indonesia's macroeconomic structural weaknesses, according to a former governor of Bank Indonesia, Soedradjad Djiwandono.
Rather, the crisis was brought about by the cascading impact of the two factors, says Djiwandono in his latest book, Mengelola Bank Indonesia Dalam Masa Krisis (Managing Bank Indonesia During the Crisis).
The structural weaknesses in Indonesia's banking and real sectors made the nation's economic resilience so vulnerable to self-validating panic, that the fallout from the Asian financial debacle (triggered by the crisis in Thailand in mid-July 1997) quickly triggered an overall economic crisis. This calamity immediately spread to the social and political sectors, which were also structurally very weak.
This book explains blow-by-blow how the contagion from the regional financial panic set off a devastating feedback loop in Indonesia that destroyed market confidence and started a vicious cycle of financial and economic collapse.
The external shock laid bare all the structural weaknesses and inefficiencies caused by rampant corruption, collusion and nepotism, thereby setting off self-fulfilling speculative attacks on the rupiah and massive runs on the banks and triggering a self-fulfilling crisis.
Many foreign economists and institutions, notably the International Monetary Fund and the World Bank, have analyzed the Indonesian economic crisis. However, Djiwandono's book is the first well-documented chronology of events by a leading member of the "fire squad" that attempted to cope with the conflagration, which is now popularly known as a multidimensional crisis.
As Djiwandono was the governor of the central bank from March 1993 to mid-February 1998, when he was summarily fired by then president Soeharto about a month before his tenure officially ended, his account of events leading up to and into the early days of the crisis is enlightening and provocative.
The book discloses many new things about the crisis, validates and disproves rumors about his working relationship with Soeharto and reveals the severe handicaps he faced because the central bank was still a tool of the government; not yet politically independent as it has been since May 1999.
He describes how the government finally abandoned the managed floating system in mid-August 1997 to protect foreign reserves because speculative attacks on the rupiah continued unabated even after the central bank poured more than US$1.5 billion into the market between the third week of July and Aug. 13 alone.
Foreign market players and fund managers, who got burned in the foreign exchange markets in Bangkok, Singapore, Manila and Kuala Lumpur, rushed to convert their rupiah assets into dollars, as they did not believe that Indonesia's managed floating system would hold much longer.
The self-fulfilling speculative attacks on the rupiah became much stronger after national players joined the rupiah-dumping stampede.
The steep depreciation of the rupiah immediately hit the corporate sector which, lulled by the 3 percent to 5 percent annual depreciation over the past decade, had built up unhedged external debts between 1992 and early 1997. As their debt service payments skyrocketed in rupiah terms, many debtors defaulted, creating giant shocks in the banking industry.
Another blow hit the banking industry after the central bank suddenly tightened its money policy, doubling and then tripling interest rates in a desperate bid to curb speculative attacks on the rupiah.
These shocks in turn exposed the structural weaknesses, inefficiencies and many other basic flaws in the banking industry, which were previously camouflaged by robust economic growth.
The book, however, fails to acknowledge that the crisis also revealed the technical incompetence and ineffectiveness of the central bank's supervisory system, and Bank Indonesia's powerlessness to deal firmly with bad bankers who were either Soeharto family members or Soeharto cronies.
As many banks fell into financial distress, panicky depositors began withdrawing deposits, forcing the central bank to pump in liquidity support to prevent the national payment system from collapsing.
However, the liquidity loans did not help much as rumors began to fly and depositors, who had never been informed about the real condition of banks due to a lack of transparency and low disclosure standards, began pulling out of other banks supposed to be still financially sound.
A panic run on the banks started at full speed.
Next the Jakarta Stock Exchange was hit, its composite index falling from as high as 612 in mid-August 1997 to 475 in early September, and most foreign banks closed out Indonesian banks.
As things rapidly worsened and the public's confidence in the government's ability to handle the financial crisis declined sharply, the government decided in early October to ask for IMF assistance.
The IMF immediately demanded that 16 insolvent banks, including two partly owned by Soeharto family members, be closed down immediately as a prerequisite to any agreement.
However, strong protests and litigation proceedings launched by Soeharto family members against the central bank governor, and the ease with which Soeharto's son Bambang Trihatmodjo acquired another bank to replace his bank which was closed on Nov. 1, further damaged market confidence in the government's seriousness and capability in handling the crisis.
The absence of a blanket guarantee (launched only in early February 1998) on bank deposits caused even greater concern among people about the safety of their deposits in national banks, thereby prompting both massive flight to quality (shifting money to foreign banks) and flight to safety (converting rupiah savings into dollars).
The book also discloses how joint market intervention with the Monetary Authority of Singapore, the Government of Singapore Investment Corporation and the Bank of Japan initially succeeded in strengthening the rupiah from 3,600 to the dollar to 3,200 in November 1997.
However, the Singapore and Japanese monetary authorities abruptly halted their market interventions, apparently due to a request from the IMF, which was disappointed by the Indonesian government's backtracking on many of the reform measures stipulated in the first reform agreement signed with the IMF in mid-November 1997. The rupiah eventually plunged to as low as 15,000 in January 1998.
The book, however, does not shed much light on the alleged misuse of about $13 billion in emergency liquidity support from the central bank, as uncovered by the Supreme Audit Agency.
Djiwandono instead blames the controversy on the fact that since the government has long been seen as a vast ocean of corruption, the central bank, as part and parcel of the government, is also seen as corrupt.
He also blames the misperception on the misunderstanding of the role of liquidity support, arguing that if such a misperception did not exist the public would accept the cost of the liquidity support.
Moreover, he argues, the parameters applied to assess normal conditions cannot be used to evaluate such a critical situation as took place during the height of the crisis.
Djiwandono asserts that the massive liquidity support was required to prevent a total collapse of the national payment system and not to protect bank owners and depositors.
Is Djiwandono really so naive as to believe that Bank Indonesia was an island of incorruptibility in the middle of an ocean of corruption?
The book also fails to enlighten the public about the technical competence and integrity of Bank Indonesia officials, notably those in charge of bank supervision, who had come under increased suspicion after audits in 1998 and 1999 disclosed how egregious the banks' violations of almost all prudential regulations had been.
Detailed explanations in the book about the central bank's supervisory system, its resources, accountability of bank supervisors and internal controls could have helped straighten out the issue.
How could violations of prudential rulings of such magnitude have occurred without the collusion of a number of Bank Indonesia officials?
Djiwandono's book is nevertheless a valuable new trove of information on Indonesia's economic crisis, because it not only provides a factual account of events, but also ventures analyses of what should and should not have been done and why similar IMF programs in Thailand and South Korea were more successful.