The preemptive bailout

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.