Managing Bank Indonesia: An insider's look at the crisis

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.