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

A presentation at the Third MEFMI Central Banks Governors Forum, Surrey, UK, May 31 1999.



  1. As it was argued previously, the Asian crisis, especially with respect to the hard hit countries, is not just a financial or economic crisis. The economic crisis has been so virulent that the social as well as political impacts have been so devastating. In fact, in the Indonesian case, the crisis is indeed a full fledged or total one. It has been creating so much human sufferings. Since the crisis is a multi facetted one, the policy measures had to address all problems associated with it, lest they would be ineffective.

  2. The problems facing crisis countries are many; one is sometime in need of some policy responses that are in contrast with another. Some of the problems are micro and short-term in nature, while the others are macro and long -term. The crisis affected different aspects of people's lives. Hence, a complex set of problems. Since the crisis has been going on for quite sometimes, almost two years by now, the problems facing the countries hit by the crisis are also include earlier policy responses, especially those ineffective ones. Discussing policy measures for recovery cannot be separated from policy measure to address the crisis itself, from the beginning of how crisis started.

  3. Recovery could only commence after the crisis is overcome. Since the crisis is encompassing many aspects of people's lives, finally it becomes a crisis of confidence. The roots of the financial crisis as many have suggested are in the weakness of banking and the unsustainable size of corporate short-term external debts. This implies a crisis of market confidence on the soundness of the banking system and the capability of corporations to repay their debts. The roots of the social and political crisis are in the structural weaknesses of our social and political systems that imply a crisis of confidence in the working of social and political institutions. All of these ultimately point to a crisis of confidence on the national leadership of each respective crisis country.


  1. Be that as it may, the first step for recovery is to end the crisis through a turning point. A turning point that could change market players to start having an optimistic outlook. When the crisis started, the market sentiment in Thailand, Indonesia and the whole region of Southeast Asia shifted dramatically, from a perception of seeing these economies as show cases of 'economic miracle' to a sudden cases of 'economic meltdown', the familiar pattern of 'herd instinct'. Fund managers all over the region voicing the same tune 'sell your local assets (currencies)' or 'buy dollar', and financial panics erupted in Bangkok, Kuala Lumpur, Jakarta, Manila, even Singapore, within a very short time. The turning point needed here is basically a reversal of that shift in market sentiment of July 1997.

  2. The turning point has to give a credible promise for political certainty, human safety, and legal protection. These have to be address first, before normal economic activities could resume. In a government lacking its legitimacy, it is very difficult to produce a credible promise as demanded by market players and the community. For the national leadership to have credibility in pushing social, political, and economic reforms, they should demonstrate a strong signal of their firm commitments on reform programs. It is very crucial that the authorities demonstrate a clear signal of firm commitments for consistent implementation of programs and policies. Market is extreme and demanding. Of course it is impossible for any government to provide immediately, robust social, political as well as economic infrastructures, that were disintegrating in the crisis. However, a positive perception that the national leadership is trustworthy and capable for doing the job, is crucial here.

  3. Market perception has to be brought to change from a negative towards a positive one. For this to happen, the market needs a clear signal that authorities could do away with old practices of crony capitalism toward a new paradigm of good governance, law and order in a transparent manner. It has to start with a turning around of people expectation from a negative to a positive one. Korea and Thailand path of recovery was preceded with a turning point. Both countries had new governments that could change market perception for the economy and the country to pull out from the crisis. At the start, the most important element is public trust to the national leaders. Positive perception is very important. Indeed, it is even more important than the substance in the beginning. But, of course, it has to be followed by consistent implementation of all the stipulated policies. Only if the national leadership could produce a turning point that it could expect public trust and support, for all the hardships that accompanied the necessary adjustments for the recovery. Starting with a positive perception, and good reform programs with consistent implementation to follow, a path towards recovery could be established.

@ Visiting Scholar, Harvard Institute for International Development (HIID), Cambridge, MA and former Governor of Bank Indonesia. (sdjiwand@hiid.harvard.edu or djiwandono@aol.com).


  1. As the crisis has been going on for sometime, close to two years by now, looking at policy response in its perspective should include steps taken in the beginning of the crisis as well as policy response towards recovery. It should be noted here, that even though we tend to generalize problems in the crisis countries as similar, they are not identical, since each crisis has its peculiarity. Indonesia could be taken as an example of a country, that despite its relatively better conditions as well as better earlier policy response ultimately tend to become the worst case in the crisis. In fact, Indonesia is the worst case in the crisis as well as the slowest in its path towards recovery.

  2. Thailand, Indonesia and Korea all went to seek for IMF supports to deal with the crisis, while other countries in Asia did not. Malaysia went on its won, while the Philippines had been on precautionary arrangement with IMF for some time. Thailand signed its first letter of intent (LOI) in July 2, Indonesia October 31, and Korea December 1, all in 1997. All these countries were granted stand-by supports under the Emergency Financial Mechanism (EFM), which was introduced one year earlier to fasten the decision process of the Board and the disbursement of the loan. Korea is the first country to receive a faster mechanism of disbursing EFM program, modified in December 1997. All these programs have two parts, the first line of defense, comprises of IMF and the WB plus AsDB, loans, and the second line of defense, loans from bilateral countries attached to support programs. These are stand-by loans to these countries and their disbursements up to September 1998.

    Stand-by loans to crisis countries in Asia
    (In US$ billions)

    Country IMF Multilateral Bilateral Total Disbursement
    IMF Others Total
    Thailand 4.0 2.7 10.5 17.2 3.0 9.2 12.2
    Indonesia 11.2 10.0 21.1 42.3 6.8 1.3 8.1
    Korea 21.0 14.0 22.0 58.4 18.2 9.0 27.2

    Source: taken from IMF, IMF-Supported Programs in Indonesia, Korea and Thailand:
    A Preliminary Assessment, January 1999 (mimeo).

  3. Of course, prior the move to go for IMF support all the three countries had made effort to deal with the depreciation pressures of their respective currency by resorting to their own means in foreign exchange management. The three countries started to response their defense against the currency onslaught by way of market intervention using their reserves in accordance with their adherence to foreign exchange management in a pegged system, either a rigid pegged system for Thailand and Korea or a managed floating system for Indonesia. One by one the three countries abandon their basically pegged system, and change their foreign exchange system to a floating one, after loosing substantial reserves in market intervention. But, when market confidence was shaken, one by one these countries went to seek for IMF support in their effort to restore market confidence. One area of discussion is definitely related to problems of determining which foreign exchange system should be adopted in the future, which I will mention later in our discussion about international financial system.

  4. In general, IMF supported program that basically is adjustment policies that a country has to take to deal with a shock or crisis. Since the 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. In general the criticisms are in the nature of arguing that Asian crisis is not typical problems that IMF was set up to deal with. 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 truth in this critic, even if not entirely. As I mentioned in the previous presentation, among the many factors causing or contributing 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. I will show later that any program of adjustments will not be effective without addressing these two problems.

  5. 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 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 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 expertise to deal with these complex problems.

  6. 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 the huge magnitudes. Thailand stand-by loan from the Fund is $4 billion, which constitutes 505 per cent of its quota. Indonesia's loan originally was $10 or 490 per cent of its quota (in July 1998 an additional $1.5 billion loan was approved), so it is more than 500 per cent of its quota. And Korea loan of $21 billion equals to 1939 per cent of its quota. In addition, each country also acquires loans from the WB and AsDB, which can be drawn relatively fast. Likewise, each country also receives some line of credits from bilateral countries, which are attached, to the IMF stand-by facility. In general these loans could only be used in the case that the source from the multilateral institutions has been exhausted. Thus, the status as a second line of defense.


It may be instructive to organize our discussion of effective policy response for recovery by first identifying the major problems facing the crisis countries, and assessing whether policy adjustments that have been implemented so far have been on target. In general problems that are facing crisis countries are as follows:

  1. There are many problems, but the major dominating problems for countries in Asia hit by the crisis are the weakness of banking system or financial system and the unsustainable short-term corporate debts in foreign currencies. These two problems are very important and inter related. Banking restructuring cannot be effective without corporate debt restructuring. Like wise, debt restructuring cannot be done effectively without banking restructuring. Banking restructuring includes closures of insolvent banks, recapitalizing weak banks and strengthening financial infrastructures.

  2. As the social impacts of the crisis have been devastating in all these countries adjustment programs also encompass steps to address social problems, like food for the poor, financial assistance to reduce school drop-outs, unemployment compensation and the likes which popularly known as social safety-net programs.

  3. All these countries, in a different intensity have also been suffering from structural weaknesses in the real sector like crony capitalism and corruption. The adjustment program has to include steps to strengthen economic institutions and improvement of governance both in the private as well as government sector. May be more in Indonesia than in other countries, reforms in the social and political system to improve social participation, transparency and democratic process in social and political conduct of the state.

1 As I mentioned before the EFM was established in 1996, but it was improved in December 1997 and again recently when IMF dealt with Brazil's problem. In the last mid-year Interim Committee Meeting of IMF in Washington DC, a new facility, the Contingent Credit Line (CCL) was introduced to deal with potential currency problems of member countries.

2 I have to admit that this game of big magnitude by adding the second line of defense has not been working well to impress the market, since everyone knows that most of these facilities are not easy to draw. In Indonesia, lack of understanding of what the second line of defense does actually mean created an unnecessary public debate and confusion in December 1997, when inadvertently theChairman of Indonesia's Chamber of Commerce and Industry announced that the Government was going to use the bilateral loan from Singapore to help small scale businesses.


  1. As stated before, the first priority is how to get out of the crisis. A turning point to shift the market sentiment is needed. And this has to be supplied by a credible national leadership that is nationally supported to shift market sentiment towards a positive one through establishing political certainty and a credible promise to guarantee stability and safety for normalcy in economic activity.

  2. On economics and finance, it is important that the social safety-net programs to deal with social impacts of the crisis executed credibly to support social and political stability. These are the now and short-term problem that have to be addressed. In the current and medium-term problems, problems of bank restructuring, in particular closing of insolvent banks and recapitalization of weak banks, and corporate debts restructuring are the highest priority.

  3. Banking restructuring and corporate debt restructuring are interrelated. It is inconceivable to have banking restructuring and leaving corporate debt problems behind. Since, part of the non-performing loan problem originated from the large numbers of corporate bankruptcy due to the crisis. However, corporate debt restructuring also has to be done in conjunction with banking restructuring due to bank involvement in corporate debts. Part of the reasons why the Indonesian case is worse than Thailand and Korea, I believe has been caused by the fact that the last two countries deal with their corporate debt problems very early in the adjustment policy programs, while Indonesia has been muddling through in this process.

  4. It may be instructive to present briefly the Indonesian experience with respect to banking restructuring. Bank restructuring is by nature a complex and costly endeavor. It has been rightly argued by many that bank restructuring is a process, not an event. For Indonesia during the crisis, since the first agreement with the IMF for a stand-by arrangement in October 1997 until the most recent one in March 16, 1999, there were 9 letters of intent (LOI) signed by the government of Indonesia. In each LOI there is a section that itemizes steps to be taken in an on-going process of bank restructuring. And since bank restructuring is closely related to corporate debt restructuring, and since its inclusion in the adjustment program, there is also a section devoted to addressing the issue.

  5. Indonesia's adjustment policy on corporate debts has been very slow due to its complexity of the problems on one hand, and the incomplete data on the other. For one thing, on the eve of the financial crisis the position of Indonesia's corporate debts had been more precarious than for instance the Mexican position before 1994 crisis. The ratio of reserves to short-term debts in Indonesia was low, close to 60%, compared to90% for Mexico. And the ratio of debt to GDP in Indonesia was close to 60%, while Mexico was around 30%. The major part of Indonesia's corporate debts was direct loan from foreign banks, Japanese and European in particular with Korean and American followed. This fact complicates their restructuring due to the fact that there are over 2000 corporations as debtors and around 100 foreign banks as lenders to deal with. In addition, many of the Indonesian corporations here are related to Soeharto family that further complicated the problems of debt restructuring.

  6. With respect to closure of insolvent banks it is important to take note of the Indonesia's problems associated with the government decision to liquidate 16 insolvent banks in November 1997. It is ironic that a step that was done to restore market confidence to the banking sector resulted in a total lost of confidence shortly after its execution. This very expensive lesson means that when public confidence is fragile, closing insolvent banks, which must be done in adjustment policy, could produce an adverse result. It may not be realistic, but bank closure should be done when public perception is not fragile. But, the sooner the better. The sooner the authorities identify the problems the better, the faster the implementation of a good program to address the problems the better. Dealing with a contagious problem has to be fast. Since the later an action is taken, the bigger the problem would become and the costlier would be the solution.

  7. With respect to recapitalizing weak banks the immediate problem is that capital is scarce for crisis countries in particular. Out sourcing is, of course, a good alternative, provided there is no constraint in financial infrastructure not domestic social and political constraint. But, at present there is also a general scarcity in world capital.

  8. As it was mentioned before, reforms and restructuring have to be supported economic, financial as well as social and political infrastructures that are also notoriously lacking in their robustness.

3 Korea experienced crisis in December 1997, but by early January 1998 some scheme of corporate debt agreements between Korean corporations and the creditors had been produced. In fact in the first Korea's letter of intent (LOI) to the IMF this issue had been addressed. Likewise, Thailand's crisis started in early July 1997 and by August some sort of agreements between debtors and creditors had been reached. Indonesia, in contrast, started to feel the financial contagion in mid July 1997, deep in the crisis in the last months of 1997, but only came up with some sort of scheme in June 1998 (the Frankfurt agreement), and only in September reached what was known since as the Jakarta Initiative in September 1998

4 For examples, Financial Reform: Theory and Experience, Gerard Capricio, et al, Eds. (New York: Cambridge University Press), 1994 and Bank Restructuring: Lessons from the 1980s,, Andrew Sheng, ed. (Washington DC: The World Bank), 1996


  1. It has become clearer that the Asian crisis has not been a single variable kind of a crisis, whether it is solely a financial panic or an economic chaos due to natural catastrophe or a disastrous policy. I could argue with more authority that in the case of Indonesia, it has been a combination of external and domestic factors that work together in the form of a contagion that ultimately results in a full-fledged crisis.

  2. To get an idea about a set of workable policies for recovery, it is important to trace how the crisis unfolded, the sequence of policy responses and market reactions that have intertwined over time. This is not an easy job because of the dynamism of events. Everything goes so rapidly that one could get confused in distinguishing causes from effects. In policy it is difficult to differentiate means and objectives.

  3. The Asian crisis shows that problems in finance and economics are closely related to social and political issues. Contagion from financial panic that hit a country seems to expose structural weaknesses of its national economy. An attack to the currency market produces a panic that ultimately implicates the banking sector and causes baking crisis. In the next round soon after, the banking crisis exposes weaknesses in the real sectors of the national economy, and after some time results in an economic crisis. Finally, the economic crisis serves to expose weaknesses of the country's social and political system, hence a full-fledged crisis.

  4. An economic recovery needs domestic supports as well as foreign supports, from industrial countries - their governments and private sectors - and multilateral institutions. All of them require some assurance from the national leadership capable of making an assurance for the creation of an environment conducive for normal conduct of business. This has to be followed with good sets of policies for recovery, good implementation and a touch of luck.

5 This is in contrast to the Thai's case or Korean's case whereby corporate debts were handled by banks which implied that the number of both debtors and lenders were less numerous.