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No. 9, September 2000
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Indonesia in Transition
Social Aspects of Reformasi and Crisis ed. by Chris Manning and Peter Van Diermen
. Institute of Southeast Asian Studies, Singapore, 379 p., 2000. (US and Europe: Zed Books, London). Get it from Amazon.com

The Indonesian Economy in Crisis
Causes, Consequences and Lessons
by Hal Hill. Institute of Southeast Asian Studies, Singapore, 153 p., 1999. (US and Europe: St. Martin's Press, New York). Get it from Amazon.com or Amazon.co.uk

Book reviews
 

The collective work Indonesia in Transition, edited by Chris Manning and Peter Van Diermen (both Australian National University), unites 22 articles and six introductions written by 30 specialists on Indonesia, mainly from Australia and Indonesia. The authors focus on the economic and political reforms, on key players such an Wahid and Megawati and their fight for the presidency, on East Timor and the Indonesian-Australian relations, on the social dimensions of the reforms and the crisis such as poverty, income, environment and the agrarian reform, on the civil society and the legal institutions, and on Islam and its role in politics.
 
In his opening address, J.A.C. Mackie identifies four major crises in Indonesia: the East Timor crisis, a looming crisis of national unity and territorial fragmentation, the crisis of democratisation and completion of the transition from the autocratic Soeharto regime to one which becomes more responsive and accountable to people, and the economic crisis of 1997-98, from which there has been little sign of a lasting recovery so far. Indonesia in Transition offers a broad look at all four crises.
 
Hal Hill is Professor of Economics & Head of the southeast Asia Economy Program at the Australian National University. He is a specialist on the archipelago. His book The Indonesian Economy in Crisis: Causes, Consequences and Lessons focuses on the economic crisis which first hit Indonesia in July 1997. The archipelago is by far the worst affected by the "Asian flu" since the economic contraction has been about twice as large as the next most affected country, Thailand. Furthermore, it is the only crisis to experience serious inflation. Its political turmoil and social tension have been much deeper than elsewhere.
 
Initially, the crisis started in Thailand and the first reaction in mid-1997 was "Indonesia is not Thailand" and around August-September of the same year, Indonesia still looked better than Thailand. Hal Hill explores the reasons why people (he too) thought so and why it ended differently. He describes the course of the crisis, and its socio-economic impacts. Hill's major argument on the causes is that it was the conjunction of many factors: political, social and economic; longer term and structural, immediate and short term; and domestic and international. Over the period 1997-98, practically everything went wrong at once in Indonesia. Hill refutes the idea of a single grand explanatory theory. Instead, he analyzes six broad sets of factors and emphasis that "the interactive effects of various vulnerability indicators, and the presence of thresholds beyond which a moderately serious crisis suddenly becomes very severe."
 
The trigger for Indonesia was Thailand. In early 1997, short term capital was flowing out and the stock market was declining. Immediately prior to and during the onset of the East Asian crisis, there was a rapid build-up and volatility of private capital flow. Indonesia's external debt was broadly stable in the pre-crisis period, at approximately 54%. By the end of 1998, it totaled $142 billion. According to Hill, there was a build up in the stock of "mobile capital", including short term debt and portfolio investments. But most of these indicators were not approaching crisis levels. More important was the stock of "liquid capital", as foreigners and residents alike took refuge from the rupiah when the deep crisis developed. It was no old-style macroeconomic crisis (government spending, etc.). But the macroeconomic management was poor. There was an attempt to set monetary policy targets and to run a quasi-fixed exchange rate with an open capital account, which first facilitated rapidly rising capital inflow, but later also outflow. Since the last major nominal depreciation in 1986, the Indonesian government had maintained its real exchange rate target. As a result, probably less than 30% of the country's private external debt was hedged. When capital flight became large scale in August 1997, the government's commitment to a targeted normal exchange rate collapsed. The official fiscal figures disguised major problems and turned out not to be correct. Still, Indonesia's macroeconomic policy settings were basically sound before the crisis. The one major deficiency concerned the exchange rate, the attempt to run a fixed rate against a backdrop of large inflows of mobile capital.
 
Poor financial regulation, political interference in commercial bank lending, premature and hasty financial liberalization and an open international capital account are widely regarded as key factors explaining East Asia's crisis. Hill agrees, they were central to Indonesia, but argues that the story is complex. Bad loans seemed to be under control, the external debt of commercial banks never reached the levels of most of Indonesia's neighbours. There seemed to be no bubble in the stock market such as in Thailand and Japan. The market index fluctuated considerably, but by 1996 was only 50% higher than in 1990. In the official data, even real estate prices seemed to be under control. The general loss of confidence in 1997 played a key role. Poor commercial decisions taken in the euphoria of the pre-crisis boom contributed to the problem. But many well-run banks and corporates were pulled down by the exchange rate collapse which caused non-performing loans and corporate insolvency. "Seriously inadequate financial data, a weak regulatory and legal framework, implicit governmental guarantees for the well-connected, and the unwillingness (or inability) to implement these regulations were of course present, and they did contribute to familiar moral hazard problems and the escalating crisis. An open capital account exacerbated the problem. The financial market lacked depth and diversity. Widespread insider trading deterred investors from the stock market. In addition, domestic credit was expanding. In sum, Indonesia's financial sector was indeed "under-regulated and over-guaranteed." But the financial vulnerability indicators were "only moderately high and the financial sector was a relative small direct player in the country's external debt." Crony capitalism, corruption and bad governance: corruption was extremely widespread in Soeharto's Indonesia, especially in the leader's family clan. Hill argues that it is "virtually impossible to reach any conclusion about aggregate trends in corruption, relative to the size of the economy, over the past couple of decades." Was it more corrupt in 1997 than in 1980? In any case, Indonesia's trade regime was more open in 1997, there were fewer NTB's and the dispersion of tariff rates was lower. There is no evidence for Hill that corruption was a "major causal variable". But it made the regime unable and unwilling to react one the crisis had hit and, therefore, affected foreign confidence.
 
Indonesia was not more vulnerable to a crisis than its neighbours. The explanation for the catastrophic events of 1997-98 lies in "the management of the crisis, which in turn was embedded in the fragile political system and escalating social and ethnic tensions". Hill provides a chronicle of policy errors. Among them are the sudden closure of sixteen banks on November 1, 1997. It immediately undermined confidence in the entire financial system. President Soeharto seemed intent on protecting his family's commercial interests at all costs. A general loss of confidence in the regime's economic management credentials was the result. Soeharto's health problems enhanced the insecurity. The choice of Habibie as Vice President had the same effect. The government signed "an impossibly ambitious agreement with the IMF", but Soeharto dismissed several of the conditions attached to it. Later, he dismissed the highly regarded central bank governor. The international community was at first rather unhelpful, according to Hill. Then, the crisis began to feed itself. Political uncertainty, loss of monetary control, high inflation, capital flight, the collapse of the rupiah. Fiscal policy, which could have helped through counter-cyclical measures to stimulate the economy, was slow to respond (for several reasons explained by Hill). But fiscal policy was not decisive, the "financial, exchange rate and political crisis were far more severe". Hill explores the role of corruption and of the IMF more in detail. In conclusion, Hill asserts that once the crisis was set up, "the political system and social texture proved quite unable to respond effectively". In this respect, the author sees parallels to the Mexican crisis of 1994-95.
 
According to Hill, the prospects for a quick return to high economic growth are mixed because of the region's economic interdependence and the absence of a regional "locomotive". The economic reform must start at home. Reform, rather than revolution. The wholesale rejection of the policy ingredients of recent decades should be avoided. The financial deregulation was a high-risk strategy. The longer term challenge is to put in place a regulatory framework. Financial data needs to be of the highest quality. The legal institutions should work cleanly and financial decision making be transparent and independent from political interference.
 
 

www.cosmopolis.ch
No. 9, September 2000
current edition & archives
Art  Film  Music  History  Politics  Archives
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Copyright 2000  www.cosmopolis.ch  Louis Gerber  All rights reserved.