Soedradjad replaced

Overall reorganization of the central bank (Bank Indonesia) had been anticipated since last week's official confirmation of the government's intention to introduce a currency board system, seen to be a quick fix solution to the rupiah volatility. Yet the removal of Soedradjad Djiwandono from the top post at the central bank, announced on Wednesday, came as a big surprise. It is, to the best of our knowledge, the first time President Soeharto has replaced a member of his cabinet two weeks before tenure in the post was due to expire.

The harsh reality could not be concealed with State Secretary/Minister Moerdiono's effusive words on 'Soedradjad's honorary discharge with the highest gratitude from the President'. The blunt truth of the matter is that the central bank governor was summarily dismissed in the face of a drastic and fundamental change in monetary policy.

But then, the present situation is by no means normal but a crisis that needs drastic, painful measures. The economy has virtually been crippled by a weakening and volatile rupiah, especially since last August, when the currency was floated, allowing market forces to determine its value. Prices have rocketed and public discontent over shortages and unaffordable prices of basic necessities has spilled over into rioting in a number of towns and cities across Indonesia.

Soedradjad, a U.S. trained economist with expertise in monetary policy, appeared to fit the bill when he was appointed governor of the central bank in March, 1993. His swift movement to toughen banking regulations shortly after taking office showed his mastery of the financial and monetary situation in Indonesia.

The banking industry in 1993 looked vibrant as a result of deregulation in October 1988. Nevertheless, Soedradjad imposed a new set of prudent regulations pertaining to disclosure requirements, higher capital standards, legal lending limits and foreign exchange exposure which were designed to ensure sound and robust growth in the industry. He also relentlessly pursued a campaign encouraging mergers aimed at reducing the number of commercial banks, which at that time numbered over 240, and tirelessly urged banks and companies to avoid excessive overseas borrowing.

Booming economies in Indonesia and across Southeast Asia drowned out his warnings. Banks pursued aggressive lending policies and borrowed heavily overseas in order to satisfy the business community's seemingly insatiable hunger for funds, even for dubious projects. A high lending margin created by the booming economy covered the inefficiencies and bad lending practice.

Soedradjad's hands were further tied by the central bank's lack of political autonomy, and by the political connections of commercial bank shareholders. He, like most members of the cabinet, was afraid of dealing firmly with politically powerful businesspeople, including bad bankers.

The hands of Soedradjad and other ardent reformers in the cabinet were strengthened when the government turned to the International Monetary Fund (IMF) for help last October. But he quickly found himself in dangerous political territory when he and the finance minister -- two of the most respected cabinet ministers due to their integrity -- closed 16 insolvent banks as part of the reform package agreed with IMF. Several of the banks had politically powerful shareholders.

At a glance, Soedradjad has become the first person to be held responsible for the financial meltdown. But public confidence in the currency does not depend entirely on monetary policy. Monetary policy is only one tool with which the government can influence the macro-economic situation, whereas the value of a currency reflects the public's confidence in the prospects of the whole economy. The political leadership itself conceded that a lack of public confidence was the root of the currency turmoil when it called in the IMF last October. It is not the reform package itself but the capricious attitude on the part of the political leadership in implementing and enforcing the reforms that has lead to the rupiah's present ailments.

We have repeatedly emphasized in this column that changes taken under duress do not carry the same conviction with the market as similar policy actions taken in more placid times. Seen in this light, Soedradjad's firing, less than two weeks before the official end of his tenure, will be unlikely to help regain market confidence -- the precious commodity we badly need to lift ourselves out of this crisis.