The preemptive bailout

The almost US$40 billion in aid pledged by multilateral institutions and country donors to the Indonesian government and the technical support and direct surveillance by an international team of experts led by the International Monetary Fund for the next three years will surely help restore confidence in the nation's economy.

Once market confidence is restored, the turbulence of the rupiah is expected to subside and gradually settle to a stable market exchange rate range. This in turn will enable businesses and the government to plan operational budgets and investment programs. A calmer foreign exchange market would enable monetary authorities to ease the credit crunch at a faster pace.

However, the government cannot yet afford to sit back and relax, because a flight with the International Monetary Fund often encounters other turbulence in the form of temporary social and political pain caused by the medicine which has to be taken.

But the strategic decision to call in the IMF and its team of macroeconomic doctors before the crisis became full-blown was quite helpful in minimizing some of the pain. After all, actions and commitments taken before a crisis becomes full-blown carries much stronger conviction with the market than the same policies taken under duress.

In the traditional standby loan of the IMF, fund disbursements are made only in quarterly tranches and, in the Indonesian case, over three years, and this disbursement depends on the government's performance in fulfilling the reform measures already set as a condition for the aid.

The government must have realized that restoring market confidence is a gradual process. The faster, bolder and broader the reform, the quicker the confidence-restoration process.

But we must admit that judging from the reform package, announced on Friday, the restoration of confidence will likely take much longer than expected. First of all, the three-year package is deficient of two important factors. First, the scope of the measures is much less than what the market had expected.

Second, the package provides only a broad outline of government intentions. It will take several days or even weeks longer to complete all the rules, decrees and directives needed to implement the program. Then, it will take some time for the ranks and files within the government bureaucracy to comprehend the agenda before it is implemented.

All this amounts to a rebuttal of the official claim that the IMF team had been called in mostly to look at the reform program already prepared by the government, to recommend the necessary changes and to provide financial and technical assistance to support its implementation. We had actually expected clear-cut measures in all their legal and technical details for at least the first of the three-year stabilization program.

Even the most concrete measure of the program -- the closure and liquidation of 16 commercial banks -- not only seemed hastily prepared, but also raised lingering questions as to the viability and solvency of some of the remaining banks. Moreover, as depositors have not been well-briefed on where they will receive their maximum Rp 20 million reimbursement, long lines formed at offices of the liquidated banks might trigger undesirable developments, which could have been avoided had technical details of the liquidation and the protection of small depositors been in place.

We portend a situation fully pregnant with jitters within the next few weeks, as the market waits for further announcements while the government works hard to stem the spread of a panic set off by the largest liquidation the nation has ever seen in terms of the number of banks closed at one time.

As the number and names of banks liquidated differed significantly from what the market had expected, the rumor mill will unavoidably set to motion temporary banking panic and runs, even on some solvent institutions. Hopefully the central bank, as the lender of the last resort, has prepared a financial safety net for illiquid, yet solvent banks which may be hit by a banking panic and run.

The central bank -- if necessary and if it is really convinced with the viability of its assessment that remaining banks are solvent judged from the standard prudential regulations and not by their political connections -- should come out with a public announcement of full support for the remaining banks.

But all in all, what ultimately counts is the political effectiveness and acceptability of good policies, because when a government suffers low credibility, credible reform measures can help restore it. Credibility is key to solving the crisis, because the situation the nation is now in will probably get worse before it gets better.

We are confident that direct IMF surveillance will guarantee against backsliding and will make sure the government will follow through with the implementation of the prescribed reforms -- or the economy will collapse.