J. Soedradjad Djiwandono@
I consider myself an insider when it comes to the Indonesian financial crisis of 1997, since I was part of the management of the national economy in the initial part of it, at least until my dismissal about one month before completing my term of office as Bank Indonesia Governor. I use the term insider in anticipation to be in slight difference from those viewing the same phenomena from the perspective of outsiders’ assessments. Of course, since we are talking about something that happened in the past, an insider’s view may also be tinted with hindsight.
Obviously in this limited space I would not be able to be comprehensive nor detailed. I will discuss some issues about the crisis that for years have been perceived as the truth, while in my view incorrect or even wrong, and issues that were raised by the editor of this section for me to answer. The issues that were put to me include; that Bank Indonesia seemed to have contributed to the worsening of the crisis and whether the fact that the central bank was under direct jurisdiction of Soeharto administration has anything to do with that. The other issues include the lessons learned by the central bank, and how have these been translated into Bank Indonesia’s capacity building and improvement of Bank Indonesia’s conducts carrying its functions.
Home grown, but not home alone
Recognizing different arguments and theories on the causes of or the process followed by the 1997 Asian crisis, it has been my contention that the Indonesian crisis is triggered by an external financial contagion, i.e. the rapid depreciation of the Thai baht in early July 1997, almost immediately after its floatation. When it hit Indonesia’s finance it ushered in a different type of contagion, from an exchange rate crisis to banking, economics and ultimately socio-political crises, which culminated in the fall of the 32 years reign of Soeharto in May 1998.
Several notes should be made here. First, Indonesia’s crisis is triggered by a financial shock in the form of contagious external currency depreciation. This implies that the Thai baht rapid depreciation was contagious and it served as the triggering factor. This does not mean that had there been no baht crisis there would never be a crisis in Indonesia. The trigger, in my view could come from other shock; it could be economics, finance or socio-politics. But, the trigger is contagious, which means that if the shock is not contagious it might not trigger a crisis. In January 1995 Indonesia experienced a currency shock originating from the Mexican’s crisis. But, it was relatively easily stabilized through Bank Indonesia’s intervention – of close to USD 600 million, supported by the widening of the intervention bands and tightening of monetary stance. Second, the contagion hit Indonesia, whose institutions were still in weak condition, embedded with structural weaknesses, i.e. the banking sector, the social system and politics. In this environment the trigger arising from the financial sector in effect acting to bring out these weaknesses into the open and the whole systems were exposed to destructive attacks. Indonesia also suffered another currency shock in July 1996, which originated from social unrest after Megawati Party’s headquarter was ransacked. The rupiah took a beating, but Bank Indonesia successfully stabilized the currency before it developed into a contagion. Of course the intervention cost Bank Indonesia another USD 700 million, but that was what reserves for in the first place.
The basic difference of the arguments and theories about the Asian crisis basically centered to the question of whether the causes of the crisis originated domestically, as weak fundamentals, cronyism and faulty policies or external, like herd instinct in finance and reverse perception. It is my contention that the Indonesian crisis is caused by a combination of external shock and domestic institutional weaknesses. I like to use the phrase they are “home grown, but not home alone” to describe the causes of the Indonesian crisis.
Bank Indonesia and the crisis
The Indonesian crisis is in a way unique that despite exhibiting similar initial conditions or vulnerabilities with other crisis countries – Thailand, Korea, Malaysia and the Philippines – and generally recognized as coming up with prudent policy responses initially, it ultimately became a basket case; suffering the worst and taking the longest time to recover. At present, ten years after the crisis most Asian economies with the exception of China, still exhibiting lower economic growth rates and lower level of investments compared to the pre – crisis levels. Despite much improvement after the crisis exchange rates of the Asian currencies are still worse than pre-crisis. And for Indonesia, despite continuing improvements its performances are worse among the former crisis countries in most respects.
Some argued that Indonesia faired the worst in the crisis due to Bank Indonesia policies that were either faulty or completely wrong. It is my contention that this argument is either unfair or incorrect. Many policies and steps were adopted by Bank Indonesia, both as part of and independent from the Government of Indonesia’s efforts to address the crisis and beyond. I would discuss some of the prominent, if controversial ones here, i.e. the decision to free float the rupiah, the policy to provide liquidity supports – the notorious BLBI – to troubled banks, the closures of the 16 banks in early November 1997, and the debate on the possible introduction of rupiah peg with a currency board – the popularly known as currency board system (CBS).
The government decision to free float the national currency in August 14, 1997 caught the Indonesian business world off-guard. It was hailed by many when it was issued, but many also blame the policy as unwarranted. The currency was depreciating rapidly afterward, partly due to the business and public responses to the government policies to address the crisis, which included everybody was scrambling for dollar either to cut loss or fly to safety. The government and Bank Indonesia’s policy to tighten monetary and fiscal stance that followed had triggered the domestic contagion. A contagion developed from currency shock to banking in distress and crisis and economic crisis there after as banks and corporate sector collapsing through balance sheet effects. In preparing for the decision Bank Indonesia offered two alternatives to the government, i.e. to widen the intervention bands further or to free float the rupiah. The government (President Soeharto) chose the latter.
The decision to invite the International Monetary Fund (IMF) was made by the government in a cabinet meeting on early September. The overriding justification for doing it was to prop-up market and public confidence on the economy and the management of the economy. This is in recognition of the fact that we were facing a global finance in the region such that the presence of the multilateral institutions would help raising market confidence. However, one of the requirements for using IMF facilities or borrowing from it has been the promise for the country to implement policies and steps stipulated in the agreement for addressing the crisis, which are known as the IMF conditionality. One of the programs in the Indonesian case was for the government to implement a comprehensive bank restructuring, which included closures of insolvent banks. In fact, the bank closure became a precondition for the use of the stand-by arrangement that Indonesia was entering into. It is known as ‘prior action’, which in effect serves as a precondition for the IMF to agree on providing a stand-by loan. This is why the closures of the 16 banks were executed on November 1 while the IMF agreement was only done a couple of days after.
Unfortunately for Indonesia, the bank closures were not just failing to bring market confidence back they even triggered by bank runs and brought the banking sector near total collapse. There have been many discussions on this issue. On the debate of why the bank closures did not succeed different arguments have been raised. Many argued that the bank closure failed because Indonesia did not have deposit insurance when the closure was made. I do not agree with the argument, since most deposit guarantee schemes only cover small depositors, which Indonesia provided at the time of the closures. The problem arose, not from small depositors, but from the big ones. In other words, if only Indonesia introduced an overall guarantee as the one introduced toward end of January 1998 (the so called blanket guarantee), the bank closures of November 1997 might not cause bank runs. I should add that if only all owners of the liquidated banks were behaving well, instead of protesting the closures by waging public campaign protesting the closures and suing the Minister of Finance and Bank Indonesia Governor to court, bank runs might be avoided.
It is interesting to note that in a conference that I helped the Rajaratnam School of International Studies (RSIS) to organize on the tenth anniversary of the Asian crisis with some former officials who were in charge in their respective countries then a similar assessment was made. In my narration about the event in my book, Bank Indonesia and the Crisis, an Insider’s View I criticized the IMF staffs for not reminding me at all about the blanket guarantee until the situation was untenable in January 1998, even when they knew by this time that Thailand and even Malaysia had introduced blanket guarantee schemes. I also learned after the crisis that other countries had introduced blanket guarantee years before when they faced with bank runs.
The most controversial policy was the provision of Bank Indonesia liquidity supports to troubled banks during the crisis. It was controversial in several aspects. This policy caused huge amount of loss to the public funds, and costing the bank restructuring close to 50 per cent of the nation GDP. And of course the policy has been associated with cases of corruption. Even to day, the public perception has predominantly been that BI liquidity supports have been a mistake, which has been unfairly put the burden to the tax payers, and that the onus is Bank Indonesia, which introduced the policy. For sure, there have been corruption cases involving bankers. Three of my colleagues all former Bank Indonesia managing directors were jailed, curiously not for corrupting money but for violating internal measures and acting imprudently in the decision to provide BLBI. The story has not come to a close yet, and there are still continuing accusations to Bank Indonesia and its officials on the issues. BLBI has become a ‘scarlet letter’ for Bank Indonesia and its officials, in particulars those serving in the board, including me.
I have been writing in different places on the issues. I would only put down some notes here. First, as the findings of the audit by the supreme audit board (BPK) showed that the total amount of the BI liquidity supports to banks up to January 1999 has been 144 T rupiah. Some considered this amount equivalent to the loss to the state finance, without any consideration on the amount of repayments by some banks and the revenues from the sales of assets of the recipient banks or even the sales of these banks themselves by the Indonesian Bank Restructuring Agency (BPPN). Second, the public generally perceived that the number of banks receiving the liquidity supports is only the number of banks managed by BPPN, i.e. 54 banks. However, the actual number of banks receiving the liquidity supports during the crisis is 130 over and not all recipient banks became problem banks that have to be managed by BPPN.
Arguments have been very strong that the total amount of the liquidity supports as mentioned before was the same as the total amount of loss. Only a few seem to go back to economics of alternative cost concept, like what would have been the cost to the economy had there been no liquidity supports provided to banks during the crisis. Would the government (BPPN) still have any right to sell privately owned banks after the crisis had there been no liquidity supports? In terms of policy, the liquidity supports for banks provided by Bank Indonesia were completely acknowledged by the recipient banks and it became the government claim to these banks. Would there still be these 136 banks that now in operation, which are relatively in good conditions had there been no liquidity supports during the crisis? Isn’t there any difference between cost and loss? For sure, a thorough analysis would have to make this distinction to be able to come up with the actual figure of the economic and financial loss of the policy, any policy for that matter.
Bank Indonesia liquidity support incurs costs and losses to our economy, yes. But, why almost no discussions were ever made on the cost of bank recapitalization? Out of more than 600 T rupiah of the total government and Bank Indonesia debt to the public, what is the biggest chunk of it? The total liquidity supports, even without reductions of the amount of assets sales by BPPN is 144T. But, why the government bonds amounted to more than four times this amount? It is due to the cost of bank recapitalization. And out of the total cost of bank recapitalization close to 300 T rupiah is the cost of recapitalization of state owned banks. Why state banks that didn’t suffer from bank runs during crisis, and thus except for one bank did not receive any liquidity supports from the central bank, had to be recapitalized that cost close to twice the amount of total liquidity supports to more than 130 banks? The state banks have not been in great shape after all. Are there completely healed after recapitalization? Of course we hope so, but problems associated with Bank BNI happened way after its recapitalization, and so was Bank Mandiri. To me, the liquidity supports that the central bank provided during the crisis and the bank recapitalization in 1999 have basically been similar in character, the first one is liquidity supports to help banks facing liquidity mismatch, while bank recapitalization is to help banks facing ‘capital mismatch’ that are closely associated with solvency problem.
I would like to stress here that I mention all these not to argue against the national efforts to eradicate corruption or to prosecute corruptors associated with the central bank liquidity supports. Indeed, all corrupt officials and bankers as well as bank owners associated with Bank Indonesia liquidity supports have to face justice squarely and fairly. I like to note that to the public understanding indeed our common sense dictates that the most important factor in corruption by officials is that these officials illegally receive money associated with the policy or action associated with them. In this case the most important is to trace the money trail, who is receiving how much illegally. We are looking at a huge amount of money, even if some is not traceable, cash transaction for example, the major part would still be through banks.
On the debate about the rumor of President Soeharto’s intention on January 1998 for returning to a peg system with the creation of a currency board and the rumor of my disagreement with the intention as well as the perceived reasoning for my dismissal as central bank governor should also be properly explained here. It is indeed true that I did not support the idea of a peg system with a currency board then. But, the main reason was not that I did not want to see the declining role of Bank Indonesia within a CBS. My concern was more on my own assessment that I could not see a consistent implementation of a currency board system would ensue in the current condition at the time. It was hard to see that President Soeharto would let the system went on its course without his high propensity to intervene or tinker. A CBS is sometime called ‘an outo-piloted system’ whereby nobody should be allowed to tinker. I was also concerned that our reserves were not sufficient to back a currency board. But, ultimately the idea was discarded in my opinion due to the mounting pressures from leaders of many western countries against the plan in addition to Bank Indonesia memorandum to the President, which basically showed that the adoption of a currency board was not feasible at that time.
Possible repeat of financial crisis
Have we learned from the past crisis? I will answer this question indirectly with my comment about the recent concern on the possibility of the recurring of financial crisis in Indonesia. Recent public concern as appeared in the media and statements by high up government officials, including the Minister of Finance that the recent development of high volume of short term capital inflows is similar to what happened in the period prior to the 1997 crisis and thus, the possible repeat of the financial crisis. I also observe the high volume of short term capital inflows. I would even add that the proliferation of property development also seems to be similar to what happened then.
However, I would not belong to those who see the eminent of a repeat of 1997 financial crisis. Why? I think a repeat of 1997 financial crisis is not highly likely at the moment. Both the conditions of the Asian economies in general as well as domestic conditions are not strong (bad) enough to trigger a shock, which could develop into a contagion of 1997 nature.
The Asian economies have generally been in a better shape compared to the conditions in 1996/97. The most important factors have been the accumulation of foreign reserves by almost all economies in Asia. The total reserves of East Asian economies are close to USD 3.5 trillion with China alone holds USD 1.2 T. Even Indonesia holds more than USD 50 billion of reserves. The current accounts of most East Asian economies have been in good shape. In addition, despite no standard pattern or well established cooperation in exchange rates among Asian economies the exchange system in most economies in East Asia is more flexible compared to the past, generally closer to a floating system than fixed. With these two favorable factors that are very different from pre crisis it is my opinion that market players do not have enough incentives to make a move for profit taking that would become a trigger for a contagion.
Furthermore, the domestic conditions in terms of the banking and other institutional structures of today are also less prone to a contagion as compared to the pre 1997 conditions. The banking sector is not as weak as in the past. The average capital adequacy ratio (CAR) of Indonesian banks is currently around 20, while just before the crisis in 1997 it was substantially less than the required 8. The average loan to deposit ratio of banks in Indonesia is currently around 60%, while in 1996 it was over 80%. At present foreign short term exposures is much smaller than the past, private sector foreign exposures are also much less. The prudential measures and their compliance as well as the conducts of monetary policy and the lender of last resort by Bank Indonesia have undergone much improvement after the crisis. And both social and political infrastructures are more robust now than the past. Thus, from both external as well as domestic environments it is my conjecture that despite the fact that the financial sector continues to face varieties of risks the danger of a repeat of the crisis is not eminent. However, this should not make Asian economies to be complacent. The world economy is facing new and different challenge the presence of unsustainable global imbalances, a huge risk for dealing with the implications of their unwinding.
RSIS, NTU, 29/06/07
@ Professor, S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University (NTU), and Retired Professor of Economics,University of Indonesia.