Seminar on IMF Conditionality
July 10, 2001

Conditionality in Fund-Supported Programs -- Overview

IMF Seminars, Conferences and Workshops

The Fund-Supported Program in Indonesia: Comparing Its Implementation Under Three Regimes*
Remarks by Boediono
Gadjah Mada University

and the Coordinating Agency for Poverty Reduction

Tokyo, July 10, 2001

Allow me first of all to thank the IMF and the Japanese Ministry of Finance for inviting me to this conference.

What I am presenting here is an account of how conditionality contained in the program, the country's ownership of the program and the implementation capacity of the government have affected program implementation in Indonesia. It is largely based on my recollection as a member of the Indonesian government's negotiation team(s) with the Fund during much of the recent crisis period. It is a story of the experience of one country as seen from a personal perspective, so I should not claim for more than its worth. It is, in my view, useful to do so, because it sheds some light on the human side of the debate. After all, the implementation of a Fund-supported program in reality involves real people. Let me begin my story from the beginning of the crisis.

In the early months of the crisis many believed that the fundamentals of the Indonesian economy were quite good and that the country could ride out the (then considered to be temporary) crisis. As late as September 1997 when we attended the IMF-World Bank annual meeting in Hong Kong, the prevailing mood among our delegations was still upbeat and if we should ask for assistance from the Fund it would only be in the form of a "precautionary" program (i.e. a Fund program without Fund money and conditionality).1 By that time, as part of our early response to the crisis the government had already undertaken steps that could be regarded as some kind of installments for such a program - we tightened the money supply, put on hold large government projects and floated the Rupiah.

But the storm continued to rage. By early October the government (in my opinion, rightly) opted to go for a full program with the Fund. The expectation of many and, I think, also that of the President, was that the crisis would be over soon and that by taking extra medicine our health would be quickly restored. The prescribed medicine included the closing of 16 banks, actions to restore the health of weak banks that remained, tight money and tight budget, and the dismantling of some trade monopolies. The subsequent events are well known and I will not go into them here.2 What I would like to note is that the ownership of the program by President was very crucial and that the influence of the interest groups on it tended to have been underestimated, especially after the program failed to deliver early results.

As it turned out, the patient progressively got worse after taking the medicine. From then on the President's confidence in the program and also in the economic team appeared to wane rapidly3. In the meantime interest groups were stepping up their efforts to have access to the President's ear, each tried to bring to his attention its particular perspectives. My sense is that by the turn of the year 1997, the President seemed to have determined to search for possible short cuts out of the crisis or at least not to put all the eggs in one basket. He may even have come to the conclusion that he needed a new economic team.

When the review mission came in January 1998 to prepare the second LOI, the economic team was involved only in parts of the whole process. The draft LOI was prepared by the mission and the negotiation was done by Mr. Fischer and President Soeharto. To the surprise of many, issues that in the past were considered intractable, i.e. those relating to IPTN and the national car, were readily agreed on by the President. But in retrospect this turned out to be just a 'paper victory'. He signed the LOI, but clearly his heart lay elsewhere.

The waning ownership at the very top did not completely prevent the program from being implemented at the lower levels of government. Technically, the implementation continued, but clearly there was no singleness of purpose. The ever-present shadow of eminent shifts of policy, and the cue from the top that alternative policies were being considered, tended to diffuse the implementation capacity below. I remember that for a couple of weeks or so toward the end of 1997, we at the central bank concentrated a considerable part of our energy to prepare the detailed blueprint for the issuance of USD-denominated government notes for the Singapore market (a policy that was eventually aborted). Similarly, the protracted debate on the currency board system and on the proposal for some kind of forced mergers among banks in early 1998 had tended to divert the policy focus from the basic issues.

The international community seemed to be sensing the evolving situation. The early months of 1998 saw a parade of dignitaries and high-level envoys visiting Indonesia with the sole purpose of urging the President to stick to the Fund program.

The implementation of the Fund program during the Soeharto era was thus characterized by a rapid weakening of ownership. The process was triggered by the President's disenchantment about the early performance of the program. His disaffection toward the program deepened as he increasingly felt pressured to accept conditionality that was repugnant to him. We can only speculate, but it is quite possible that things might have turned out differently had the conditionality (particularly in the first two LOIs) been confined to the one that was really critical for handling the emerging crisis (which certainly should include a comprehensive banking reform), while the one which was not (such as the dismantling of clove monopoly, IPTN and the National Car project) could be postponed until our head was above water. One could argue that when things got better, the sense of urgency waned and it would take a hard fight for the reformers to make a change. But it might still be better than engaging in a virtual fight that produced a 'paper victory'.

What about the implementation capacity? In that period the implementation capacity of the government did not appear to be a binding constraint. It is true that the communication between the President and some members of the economic team grew more difficult and, admittedly, the teamwork among the core members of the economic team was not always the best of all times.4 They must have impaired the program implementation somehow. But in the more operational sense things seemed to be still in place. The existence of the Monetary Board and the ever presence of persons like Professors Widjojo and Ali Wardhana and State Secretary Moerdiono in the background ensured that a minimum degree of coordination among members did occur. The bureaucracy, with all its shortcomings, was functioning. In a stark contrast with the present situation, the parliament then seldom, if ever, posed a problem for the government to push through its policy agenda. During this period it was thus ownership, not implementation capacity, which set limits to the program performance.

As the year 1998 unfolded, the general condition of the country deteriorated rapidly. The payments system broke down, production in many sectors collapsed, the country experienced one of the most severe draught in many decades and hyperinflation set in. Protests and social unrests broke out with increasing frequency and intensity. Then in May a sudden change in government occurred and Mr.B.J.Habibie was the new president. The Habibie era was a short but highly unusual period. In retrospect, despite the unsettled social and political condition, it was a time when the Fund-supported program actually stood the best chance for its full implementation. It was a period when the ownership of the program was strongest while the implementation capacity of the New Order remained more or less intact. Whatever other failings one may ascribe to the regime, its achievements in the economic field cannot be lightly dismissed.

First, about program ownership. I believe that President Habibie clearly recognized his strategic options. He knew that of all the avenues open to him then, to fix the economy was likely to earn him the greatest score, hence the chance of his reelection. Moreover, the blueprint to do that was readily in hand. It was spelled out in detail in the revised program agreed with the Fund on June 24, 1998. Thus it was his best bet to throw his full weight behind the program.

Mr. Habibie, the technologist, was often pictured as a man whose intellectual and policy positions were diametrically opposite to those of the economic technocrats. It was thus a big (and pleasant) surprise to me when, as a member of his cabinet, I found that Mr. Habibie, the President, was actually quite open to policy proposals manifestly based on mainstream economic reasoning. In his first presidential speeches, he stressed the imperative to have an independent central bank and functioning competitive markets. You could hardly be more 'mainstreamed' than that! Despite the rather unusual theory about inflation and interest rate that he expounded when he was vice president, we found that it was not difficult to convince him that a really tight monetary policy was necessary to break the prevailing inflationary spiral.5

Let me relate another little story. In one of the policy meetings chaired by the President in early 1999, I had to present the proposed development budget for the coming year. After describing all the facts and figures of the budget I closed my presentation with a statement something like this: "Mr. President, what we have here is a zero-sum-game. So, if you instructed me to increase such and such spending, it is important that you also tell me which other spending I should slash." The proposed budget was approved almost without modification. But what gave me a particular pleasure was when I learnt that he, who was often pictured as a 'big spender', actually repeated that punch line in a number of other occasions to drive home the meaning of budget constraint to ministers.

Forging a convergence of views between the economic team and the President and even among the members of the economic team was not always a smooth sail, especially when we came to some aspects of the structural conditionality of the program.6 But in general and for many basic issues such a convergence was achieved, often through a real debate between the President and the economic team - something that was unthinkable in the setting of the previous regime. Let me cite two examples.

I remember when in February 1999 we were approaching a scheduled wave of "cleaning up" of the banking sector (a combination of bank closures and recapitalization) a disagreement emerged between the President and the economic team regarding the status of some banks included in the list. The original list was the product of an in-depth investigation by a special interdepartmental team with extensive involvement from experts from the Fund and the World Bank. The issue became a bit protracted draining our energy for more than one week. But in retrospect it was worthwhile because in the end, with some modification and a little delay, the original list was basically implemented, and we all stood by that decision. In March 1999 the government closed 38 banks and took over 8 for possible recapitalization.

There was also an occasion in late 1998 when the government had to decide what to do with the majority owners of banks with large debts to the government. The principle of out of court settlement was readily agreed by most, including the President, because it promised the maximum asset recovery so vital for the budget. One sticking point was how the settlement was to be effected. The President insisted that the debts be paid in one year in cash. Most of the members of the economic team thought that it was not a realistic position and some alternative settlement schemes were presented. The "deadlock' lasted for several days and its resolution was helped by a brilliant idea from one of the government senior economic advisers. Following his suggestion, one evening the economic team saw the President and urged him to call Mr. Hubert Neiss to get his perspective on the issue. There was a long dialog over the phone between the two (it was in German all the way) and the economic team patiently waited. The waiting was worthwhile for afterward a compromised scheme was struck.

There was one particularly sensitive issue in the LOI - the one related to IPTN - that the team members always took a great care not to raise to the President, unless it was absolutely inevitable. The topic invariably led to a long discourse and we could sense the anguish (and, I guess, also anger) on the part of the President when he talked about the fate of his brainchild. Raising that topic would guarantee spoiling the whole session with him.

Let me now turn briefly to the issue of implementation capacity. In spite of the great political uncertainties surrounding the period, the government was able to maintain a reasonable degree of implementation ability because of three factors. First, notwithstanding the differences in their background, members of the economic team did operate as a team. The gravity of the situation at that time probably helped forge the teamwork.7 The team spirit helped create a relaxed but quite effective interaction among the team members, which in turn facilitated the implementation of policies. Second, the bureaucracy inherited from the Soeharto era, with all its shortcomings and strength, remained more or less intact. It still retained its responsiveness to command, a feature crucial in times of crisis. There were changes at the top layers, but many stayed in their positions. Third, the parliament was dominated by the government party (Golkar) and although by then the new political winds had begun to inspire parliamentarians to be more vocal and independent in their views, there was generally no major handicap for the government to win approval for their policy agenda.

The implementation rate of the program was generally high until close to the end of the Habibie era, when the East Timor problem and the Bank Bali case became highly charged and contentious issues. It is interesting to speculate whether such a performance could have been maintained had Mr. Habibie succeeded in getting reelected. Leaving aside those two sticking issues, the answer depends on whether the positive factors that had contributed to good program performance could be maintained. Could the singleness of purpose at the top be sustained? Could the President and his economic team insulate the agreed basic strategy from the pulls and pushes by sectional interests, which almost surely would emerge and consolidate themselves around the power centers? Could a rapid communication and candid interaction between the President and his economic team, and among members of the team, be maintained? Could a bureaucratic reform, which is widely demanded, be carried out in an orderly fashion such that at least a minimum degree of its effectiveness and responsiveness be maintained all along? Could the government develop workable relations with the Parliament and with the regions so that the main elements of the basic strategy could be implemented? Affirmative answers to all these questions are basic ingredients for any successful government.

The change in government in October 1999 has brought with it quite a different setting for the implementation of the Fund supported program, generally making it less certain. I have since left the government and what I can relate here is my observation from outside the establishment.

When President Abdurrahman Wahid took office there was a high hope for a calmer social and political climate and a speedier recovery of the economy. The first LOI that the new government agreed with the Fund on January 20, 2000 contained an unusually long list of structural conditionality. In a meeting between the (Indonesian) National Economic Council (of which I was a member) and the Fund mission at that time, concerns were already raised that the conditionality and the associated timetable appeared to be well beyond the capacity of the new government to deliver. It appears that in the early months of the new regime this capacity constraint was not fully appreciated (by both the government and the Fund) but became obvious soon after. The program implementation capacity has since declined for at least three reasons.

First, the teamwork and the chemistry of economic ministers have somehow been missing all along. The subsequent rift between the government and Bank Indonesia further compounded this problem of coordination.

Second, the bureaucracy is sliding into a state of paralysis because of the uncertainties with regard to where the reform process is heading. The incomplete and rather confused process of regional decentralization further complicated the problem.

Third, the relation between the government and the parliament has continued to worsen and has recently reached a dangerously destabilizing state. In such a situation it is difficult to expect a high rate of program implementation.

What about ownership? It is difficult to gauge the degree of ownership of the program in the new setting. In theory, the ownership of an agreed program in a democracy should be stronger than in a more authoritarian state. In Indonesia today, that premise is not obviously true. Are there now more people or officials who feel bothered when slippages in program implementation occur and try to do something about them? I remember how frequently in 2000 Professor Emil Salim, then the Chairman of the National Economic Council, had to make his rounds within and outside the government calling attention to the fact that such and such commitments in the LOI were due.

Let me conclude my talk with a two-pronged statement. There are indeed formidable problems that plague the implementation of our program. But as our story implies, all these problems are actually within our historical capacity to fix.

Thank you.

* Presented at the IMF Seminar on Conditionality, Tokyo, July 10, 2001.

1 The Minister of Finance Mar'ie Muhammad and the Governor of Bank Indonesia Soedradjad Djiwandono led the Indonesian delegations.

2 See for instance, Charles Enoch et. al., Indonesia: Anatomy of a Banking Crisis - Two Years of Living Dangerously 1977-99, IMF Working Paper, WP/01/52, May 2001.

3 During this period, the economic team roughly corresponded the Monetary Board which then consisted of the Minister of Finance, the Coordinating Minister of the Economy and Finance, Bank Indonesia Governor and the Minister of Industry and Trade. In the background were Professors Widjojo Nitisastro and Ali Wardhana and the State Secretary Minister Moerdiono as expert members of the Board.

4 My impression is that more candid communication between the President and the economic team was done through 'intermediaries', namely Professor Widjojo and Minister Moerdiono.

5 If I understand it correctly, his theory was based on a statistical analysis of the Indonesian inflation and interest rate data going back to the 1960s. He found that that there was a negative long-term relation between interest rate and inflation and therefore the appropriate policy to control (long run?) inflation was to keep the interest rate low. The possibility of reverse causality was not considered.

6 During this period, the 'core' economic team consisted of the Coordinating Minister for the Economy and Finance, the Minister of Finance, the Minister of Industry and Trade, the Minister of Planning, the Minister of State Enterprises and the Bank Indonesia Governor.

7 Of no less important factor was the effective coordination by the ever-assertive Coordinating Minister for the Economy and Finance, Mr. Ginandjar Kartasasmita.