By : J. Soedradjad Djiwandono
Gurubesar tetap Ilmu Ekonomi, Universitas Indonesia

Points for presentation at a seminar for the Mason Fellows on Globalization and Governance, Kennedy School of Government, Harvard University, November 4, 1999.


  • My presentation on Indonesia's economic management during the recent crisis would hopefully fit in the themes that the Mason Fellows' seminar are focusing this time, namely issues on globalization and governance. The Indonesian crisis, in fact Asian crisis could indeed be seen as an implication of the integration of each national economy into a global one. Through a process of contagion a currency crisis in an economy spread to different countries in a high-speed trough different transmission mechanisms. The process of contagion worked very rapidly through different innovations in techniques of financial inter-mediation and financial institutions, supported by rapid liberalization in the world economy.

  • The Indonesian crisis also showed that within a country the process of contagion worked through different sectors and activities such that one could observe the unfolding of a crisis that originated from a shock in the currency market, but in a short period turned into a full-fledged crisis, involving almost every aspects of people's lives. If Asia has been the hardest hit region in the crisis, Indonesia has been the worst case in the Asian crisis.

  • Discussions on the origins or causes of the crisis have been going on for some time now. Over time, differences between competing views on the explanation of how the crisis unfolded have been narrowing. However, consensus has been less in terms of what could we learn from the crisis, and still much less so in what should be the effective policies to face future crises.

  • Be that as it may, it seems to be correct to say that among the many factors causing or contributing to the Asian crisis, there are two problems areas that in general people accept as the major problems facing the national economies in the region, i.e. the weaknesses in the banking system and the unsustainable amount of corporate debts in foreign currencies.

  • Discussions on causes of crises are within the topic of globalization while policy adjustments towards resolving them are closely related to issues of governance and transparency.


  • As the crisis has been going on for more than two years by now, policy responses to the problems and market reactions, including their feedbacks could be highlighted well with the benefit of hindsight. Some comparison could also be drawn from experiences in different countries in Asia. It should be noted here that even though some -- market analysts, rating agencies -- tend to treat problems in the crisis countries as similar, they are not identical, since each crisis has its peculiarities. Indonesia could be taken as an example of a country that despite its relatively better condition and better earlier policy responses it turns out to become the worst case in the crisis countries. It is also the slowest in its path towards recovery.

  • The virulent nature of the Indonesian crisis includes very dramatic growth reversal and capital flows reversal, the worst currency depreciation since the great depression, dramatic increase in the rate of unemployment, people live below poverty line as well as school drop outs, increases in crimes, plus dramatic political development that ends 32 years of a stable but authoritarian rule. The crisis has been causing so much human sufferings.

  • The Indonesian crisis developed from a combination of an external contagion and structural weaknesses of the national economy. It started as an external shock originated from Thai baht rapid depreciation in early July 1997, which turned into a regional financial panic that hit the Indonesian currency market and caused the Rupiah to depreciate drastically. Facing the shock, the national economy that was embedded with weaknesses in the banking as well as real sector started disintegrating. A contagious process developed whereby a currency shock very quickly spread to become banking crisis, and soon after, economic crisis. And since the social structure as well as the political structure was also suffering from weaknesses, the contagion worked quickly to hit the social and political foundation as well, and ultimately Indonesia experienced a full-fledged crisis that adversely affecting almost every aspects of human life. A process of contagion originated from a financial panic due to a shift of market confidence in the neighboring countries hit Indonesia in mid July 1997. This shock revealed weaknesses in the banking system that in turn creating a distress and crisis in banking. The banking crisis exposed weaknesses of the national economy due to crony capitalism and corruption, and leading towards an economic crisis. In turn, the economic crisis revealed structural weaknesses of the social and political system, such that ultimately Indonesia suffered from a total crisis.

  • Among Asia's crisis countries Thailand, Indonesia and Korea all went to seek for IMF supports, while other countries in Asia did not. Malaysia proceeded in facing the crisis on its own, including resorting to capital control. But, before being sacked Minister of Finance Anwar Ibrahim was known for subscribing stringent policies of the IMF tradition. Meanwhile the Philippines had been on precautionary arrangements with the IMF for some time.

  • Before going for IMF support all the three countries had been dealing with strong pressure on their respective currency by resorting to their own means of foreign exchange management. The three countries started their defense against the currency onslaught by way of market intervention in the foreign exchange market in line with their adherence to foreign exchange management with a pegged system, either a rigid pegged system for Thailand and Korea or a managed floating system for Indonesia. After loosing substantial reserves in market intervention, in particular for the first two countries, one by one the three countries abandon their basically pegged system, and change their foreign exchange system to a floating one. But, when market confidence was shaken, one by one these countries went to seek for IMF support in their effort to restore market confidence and obtain financial support.

  • In general, IMF supported program contains adjustment policies that a country promised to take for dealing with imbalances from a shock or crisis. Since the Asian crisis is multifaceted, reflecting varieties of problems and weaknesses, a sustainable program to effectively addressing problems of crisis must comprise of several aspects also. There have been a lot of criticisms on the IMF handling of Asian crisis. The general criticism is that Asian crisis is not a typical problem that IMF was set up to deal with. In one of his recent speeches Mr. Camdessus acknowledged the structural constraint of the institution that by design it was supposed to face a different environment from the present one.

  • There are slight variations in each country, but generally the IMF-supported programs adopted to face the crisis comprise of financial reform and economic restructuring complemented with prudent monetary and fiscal policy. The classic IMF approach is of course monetary and fiscal policy to address monetary instabilities, like inflation and balance of payments as well as fiscal imbalances. But, dealing with problems in economic structures, like monopolies and oligopolies and practices of crony capitalism, granted that these are real issues in these countries, have raised controversies. And addressing problems of banking restructuring as well as corporate debts also managed to draw some criticisms. As one should also acknowledge, in all these cases the Fund had been working together with its sister institution, the World Bank (WB) as well as the Asian Development Bank (AsDB) so that they could mobilize a pool of experts to deal with these complex problems.

  • Since the problem facing these countries is basically one of market confidence, the presence of these multilateral agencies supporting these countries is very crucial. They have to show their support of these countries' adjustment programs with their expertise as well as the availability of funds, both in term of the magnitude and its readiness to be drawn. Hence, the Emergency Financial Mechanism (EFM) and its huge magnitudes.

  • In general Asian countries did not suffer from problems of budget deficit, hyperinflation or even chronic balance of payments' deficits. But, the IMF therapy, at least the one usually highlighted, is tight money policy with sky-high interest rates. There is some validity in the IMF critics, even if not entirely. However, among the many factors causing or contributing to the crisis in Asia, the common important elements are that these countries have been facing problems of weak banking or financial system and unsustainable corporate short-term debts in foreign currencies. For this any stabilization and recovery program will not be effectively solving the crisis unless seriously addressing these two problems. For Indonesia, since the crisis has become a multifaceted crisis with dynamic feedback effects in a complex inter-relation between sectors, financial and economic recovery could only come out after a positive development in the political system could produce a turning point for a more sustainable process of recovery and beyond. The new government under President Wahid seems to have a better chance to make a much needed turning point for a sustaining process of recovery.


  • Even though discussions on different approaches to deal with problems in specific policy areas have been going on for some time, it is the recent crisis that has become the 'wake-up call' for governments and monetary authorities of many countries as well as multilateral institutions to be more focus on new strategies or approaches on various aspects of development. Studies on banking crisis and banking soundness for macroeconomic policy by IMF and WB staffs had started in 1991. However, it was only after the mid nineties that these studies were getting more explicit on the need of more integrated approach of micro and macro aspects of economic policy due to a better understanding about the close link between soundness of banking system and monetary management. In economic development a holistic approach has also been emerging.

  • Stiglitz argued that development represents a transformation of society, a movement of traditional relations, traditional ways of thinking, and traditional ways of dealing with health and education, traditional methods of production, to 'modern' ways. A successful development transformation affects not only what we do, but also how we do it; it affects the strategies and policies, as well as the process. He reminded something very relevant for Indonesia's future development, namely that an economy needs an institutional infrastructure.

  • We have seen the evolution of approaches or theories in development; from growth theory (50's and 60's) to growth with equity (70's), up to the recent dogma of focusing on adjustment policies for the functioning of market economy (late 80's and the 90's prior to the crisis). In the most recent approach of development, the guiding principles have been the so-called Washington Consensus, with the dictum of liberalization, stabilization, and privatization. With the benefit of hindsight, most writings after the emergence of the crisis argued that there are requirements to be fulfilled for the implementation of the Washington consensus to be effective. Some would even argue that the Washington Consensus is not right. What could be said here is that, trusting the Washington consensus dictum blindly like a true believer or implementing it unintelligently could lead to confusing means with ends with costly implications, as some crisis countries had attested.

  • The Indonesian experience in liberalization policies, I think, had this downside. Many Indonesians, during the heyday of liberalization drive would take almost for granted that "deregulasi" is an end itself. The crisis showed us clearly that our banking liberalization was not executed intelligently. And we have to pay dearly. Of course, after the crisis, there are writings, IMF staffs' included, and belatedly advising to liberalize prudently, or that liberalization in financial sector has to be accompanied or even proceeded by robust financial infrastructures. Similar problem arose in privatization policy. Privatization and trade liberalization is means to pursue a more sustainable, equitable, and democratic growth. They are not ends in themselves. Strengthening banking system is part of economic fundamentals for economic stability, as we believe that prudent fiscal and monetary policies are. A failure to understand the subtleties of the market economy and concentrating almost exclusively on getting prices right, is not enough to make a market economy work. The weakness or absence of financial, social, legal and political infrastructures were never seriously considered as necessity for a market economy to function as promised. These could be part of what one learns from the crisis, policy responses as well as market reactions to them.

  • The recent crisis has revealed structural weaknesses of, not just Indonesian financial infrastructure, but also social and political infrastructure. These weaknesses made Indonesia the worst crisis country. Indeed, it has been argued by many that Indonesian path of development has left out institutional development. A robust infrastructure in economic, finance, social and politics has to be part of the new paradigm for Indonesian development. One very important aspect of this problem is the weak legal system in Indonesia. A combination of structurally weak legal system and a concentration of power on the executive branch (the President) of the system of government have caused resolution of banking or financial disputes through legal action ineffective. Strengthening economic, social and political infrastructures has to be part of the national effort to build a new paradigm of Indonesian development.

  • The recent crisis shows us that in spite of a relatively high rate of national savings, Indonesia has been living beyond the means that made development process unsustainable. Even though the national saving has not been bad, Indonesia keeps having problem of financing S-I gap. Indonesia has to address the problem of S-I gap, from both the expenditure as well as the saving side. Corporations have to reduce the habit of highly leveraging. Corporate debt to equity ratio in Indonesia has been notoriously very high. At the family level consumerism had been continuously rising for many years prior to the crisis. For a sustainable development financing has to be done within the national means.

  • We may even argue that the root of corruption, collusion and nepotism is a way of life that is based on living beyond one's means. Corruption, collusion and nepotism that are rampant in the deep-rooted crony capitalism of Indonesia are involving two parties, the recipient and provider. Both parties have to be uprooted from Indonesia's process of development. Professionalism, good governance and transparency should replace these practices. As the IMF Managing Director aptly summarized in his Konrad Adenauer speech…." In a nutshell, the crises of the last decade have suggested and, in fact, have made imperative fundamental lessons: First, the golden rule of transparency. Second, good governance as universal 'must' both for the private and public sectors. Third, the importance of the triangular relationship between monetary soundness, high quality growth, and poverty reduction….."