Life with the IMF: Indonesia's Choices for the Future
IMF News, July 15, 2003
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- Published: July 15, 2003
I. Purpose and structure
- Paper presented at the 15th Congress of the Indonesian Economists Association, Malang, Indonesia, July 15, 2003.
- Organizes analysis into: historical backdrop; IMF policy advice during the Asian crisis (macroeconomic, banking, structural conditionality, nature of relationship); recent performance and remaining challenges; IMF-member relations and options; post-crisis country comparisons; lessons learned and concluding thoughts.
II. Historical backdrop and development achievements
- Rapid socio-economic progress (1975 → 2000):
- GDP per capita: US$470 (1975, current PPP basis) → US$3,040 (2000).
- Illiteracy rate: nearly 40 percent → 13 percent.
- Life expectancy: 51 years → 66 years.
- Infant mortality: declined by two-thirds.
- Comparative example: Nigeria vs. Indonesia (1975 → 2000)
- Indonesia's per capita income ~15 percent above Nigeria in 1975.
- By 2000, per capita income in Indonesia roughly 3½ times higher than in Nigeria.
- Life expectancy gap: 7 years in 1975 → 19 years in 2000.
- Main explanatory factor for Indonesia’s outperformance: macroeconomic stability plus sound structural policies; vulnerabilities arose from weak governance and institutions.
III. Causes of the Asian crisis and policy responses
- Common vulnerabilities across crisis countries:
- Inadequate regulation and supervision → misallocation of credit, inflated asset prices, excessive unhedged foreign borrowing.
- Deceleration in export growth from 1996 triggered deterioration in loan portfolios, investor confidence loss, and speculative attacks on currencies.
- Cross-country recovery differences:
- Korea: GDP per capita recovered to 1997 level in 1999; regained market access in April 1998 with a heavily oversubscribed $4 billion sovereign bond (two tranches: $1 billion due March 2003 and $3 billion due March 2008; spreads 345bp and 355bp).
- Thailand: returned to precrisis GDP per capita levels in 2002; stronger FDI (rose by roughly $1.5 billion in 1998).
- Indonesia: real GDP per capita in 2002 was still about 5 percent below its 1997 level; investor confidence recovery slower; average net FDI roughly same as Thailand but about $5 billion per year lower than mid-1990s; net portfolio flows negative or near zero until 2002.
- Multifactor causes of Indonesia's severe crisis:
- Fundamental weaknesses in financial sector, unhedged corporate foreign debt, institutional weaknesses, political instability (notably concerns about President Suharto's health and the March 1998 presidential election culminating in resignation on May 21, 1998).
- IMF role and criticisms:
- Initial IMF-supported program (October 1997 LOI) assumed a moderate contagion; expectations were for quick stabilization.
- Implementation problems: policy reversals, poor communication, lack of commitment at highest political levels undermined stabilization.
- Transparency lesson: publication of LOIs and clear communication found to be critical confidence-building measures; IMF practice changed post-crisis (between January 2001 and March 2003, 93 percent of all LOIs were published).
IV. Evaluations of specific policy areas during the crisis
- Fiscal policy
- October 1997 LOI proposed modest fiscal tightening for 1998/99; by third LOI (April 1998) deficit target raised to nearly 5 percent (to allow temporary subsidies to protect the poor).
- Actual 1998/99 budget deficit: 2.3 percent of GDP (1997/98 deficit: 1.3 percent of GDP).
- Ex post view: initial targets were tight; IMF might have pushed earlier for looser stance though market reaction is uncertain.
- Monetary policy
- Policy dilemma: "twin crisis" (exchange rate and financial sector).
- Bank Indonesia (BI) one-month SBI rate: increased from 10 percent to 30 percent in August 1997; reduced from 30 to 20 percent between early September and late October 1997; stayed at 20 percent until late January 1998 when raised to 22 percent.
- Liquidity support escalation:
- End-October → mid-December 1997: Rp 6.5 trillion → Rp 31.7 trillion (5 percent of 1997 GDP).
- By end-March 1998: Rp 97.8 trillion.
- Result: base money grew by 14 percent (last quarter 1997) and 32 percent (first quarter 1998), accommodating currency depreciation and inflation surge.
- Monetary policy was not effectively tight until March 1998; exchange rate movements:
- Rupiah peaked at Rp 13,600 in late January 1998.
- Appreciated from Rp 9,750 in mid-March to Rp 7,500 by mid-April 1998; remained below Rp 8,000 until May 1998 political turmoil.
- Historic low: rupiah hit Rp 15,250 per U.S. dollar on June 17, 1998.
- Capital controls assessed but deemed impractical given administrative capacity; Malaysia introduced controls in September 1998 (after regional currencies had begun to appreciate).
- Banking sector policy
- Pre-crisis banking vulnerabilities: rapid expansion post-1988 deregulation without strengthened prudential regulations; concentrated ownership and weak corporate governance; increased unhedged foreign borrowing.
- International audits later confirmed deep underlying problems: high delinquent loans, connected lending, political interference or weak supervisory enforcement.
- Reference data problems: BI data reference date June 1997 inadequate for solvency assessments; lack of timely stress-test capacity.
- Institutional integrity weaknesses undermined rescue strategy; three controversial elements:
- Closure of 16 small banks (November 1, 1997): these had a market share of 2.5 percent; initial public approval eroded by policy reversals (e.g., bank owner allowed to reopen under another name).
- Deposit guarantee: IMF and authorities initially opposed blanket guarantee due to fiscal cost and moral hazard; adopted a partial guarantee—but rules were poorly communicated, reducing confidence effects.
- Bank liquidity support (BLBI):
- Program originally precluded large-scale liquidity support under tight money program.
- Authorities provided large liquidity support at below-market rates and on unsecured terms contrary to IMF advice.
- By mid-1998 total liquidity support reached Rp 140 trillion, or 37 percent of 1998 GDP.
- Estimated misuse: roughly Rp 82 trillion misused; "shareholder settlement agreements" negotiated later with disappointing recoveries.
- Resolution: IBRA recoveries and bank divestments later contributed to reducing public debt and improving investor sentiment.
V. Structural conditionality and reform outcomes
- Debate: critics argue structural conditionality undermined confidence by highlighting fundamental weaknesses; authors note structural problems predated crisis.
- October 1997 LOI structural measures largely general and to be implemented over program; poor communication led to public speculation.
- January 1998 LOI emphasized more specific time-bound structural conditionality to signal a break with the past; political commitment was weak.
- Examples of successful structural reforms:
- Deregulation of agriculture (January 1998): reduced local monopolies and allowed farmers to retain a higher share of market prices.
- Abolition of clove monopoly: enthusiastically received by clove farmers and traders.
- Corporate sector restructuring efforts:
- INDRA (foreign exchange guarantees) was not successful.
- JITF provided technical support and oversaw restructuring of roughly $20 billion in corporate external debt through June 2003.
VI. Recent performance (as of June 2003) and remaining challenges
- Key macro-financial indicators (June 2003):
- Exchange rate: near Rp 8,000 per U.S. dollar.
- Inflation: under 7 percent in June 2003 (single digits).
- Interest rates: fell from nearly 18 percent in December 2001 to roughly 9 percent (around June 2003).
- Public debt burden: declined by roughly 20 percentage points, to 83 percent of GDP between 2000 and 2002.
- Reserve cover of short-term debt: increased from about 85 percent at end-2000 to about 150 percent (present as of June 2003).
- Financial sector progress:
- IBRA recovered over Rp 110 trillion in cash and roughly Rp 17 trillion in recapitalization bonds from bank-related assets.
- Majority stakes in BCA, Niaga, and Danamon sold in competitive tenders; IPO for Mandiri was successful.
- Gradual increase in mandatory capital adequacy ratio and creation of a comprehensive financial sector safety net.
- Remaining structural and institutional challenges:
- Investment climate weaknesses limiting transmission of lower interest rates into credit:
- Decentralization risks: potential for complex and unstable local regulations and taxes.
- Customs and tax administration: reported deterioration in transparency, predictability, and fairness.
- Labor market policy: need balance between worker protection and labor market flexibility.
- Legal and judicial reform: need for Anti-Corruption Committee, bankruptcy law amendments, and strengthened commercial court.
- Capital flow composition: much recent inflow short-term in nature; readiness needed for possible reversals.
- Transparency shortfalls: LOIs published but IMF staff reports for Executive Board not approved for publication by authorities; Indonesia had not participated in IMF ROSC modules or FSAP by mid-2003.
VII. Indonesia–IMF relations: options, benefits, and decision factors
- Key benefits of IMF membership and arrangements:
- Exceptional financing during balance of payments need (available under an arrangement; precautionary arrangements commit resources but the member does not intend to use financing unless needed).
- Access to Paris Club debt rescheduling only in context of a Fund arrangement.
- Endorsement of economic policy via Executive Board approval and program reviews under an arrangement.
- Policy dialogue: 2-4 reviews per year under an arrangement; post-program monitoring and surveillance provide less formal endorsement.
- Public release of information: program reviews yield Public Information Notices (PINs); frequency higher under an arrangement.
- Technical assistance: ongoing access to IMF TA in fiscal, monetary, banking, statistics, legal, and other areas (Box 2 lists specific TA areas).
- Decision considerations for Indonesia post-arrangement:
- Will exceptional financing be needed?
- Would periodic dialogues with IMF strengthen policy formulation?
- Would IMF association enhance confidence with other official creditors (World Bank, ADB) and financial markets?
- Will technical assistance be required?
- Practical observations from other countries (sample: Korea, Thailand, Brazil, Mexico, Russia):
- Except Russia (program off-track), selected countries maintained arrangements that turned precautionary before conclusion, suggesting benefits beyond financing.
- Post-program monitoring followed arrangements for varying periods.
- Sample countries generally had stronger sovereign credit ratings than Indonesia’s B- rating at the time.
- Example: Brazil’s program helped stabilize market sentiment during a charged 2002 presidential campaign because all candidates endorsed the Fund program.
VIII. Lessons learned and concluding thoughts
- Key lessons:
- Need for in-depth understanding of financial and corporate sector fragilities and for adequate institutions to monitor and address them; IMF and World Bank increased staff in these areas and emphasized balance sheet analysis.
- Importance of transparency and effective communications strategy to manage public and market expectations; LOI publication and participatory program design are helpful.
- Success of Fund-supported reform programs depends critically on government ownership and support across the body politic.
- IMF has increased outreach to civil society to solicit views and explain its role.
- Final policy priority:
- The critical requirement for Indonesia is to build on recent macroeconomic stabilization by designing and implementing a reform program that sustains macroeconomic stability and advances institutional and structural reforms; the choice of future IMF relationship should be determined by Indonesians based on what best supports their economic and development strategy.
- The IMF stands ready to assist in the manner deemed most appropriate by Indonesia.
Source: Jack Boorman and Andrea Richter Hume, "Life with the IMF: Indonesia's Choices for the Future", presented July 15, 2003.