Ethos Issue 3, Oct 2007

Indonesia in the Financial Crisis: Advent and Aftermath
Interview with Adam Schwarz

Do you disagree with critics like Jeffrey Sachs who argue that the IMF measures were incorrectly prescribed and exacerbated the crisis?
There is some validity to that view. But my own view is that the IMF had few choices to the path it took. Hypothetically speaking, if the IMF had adopted a much more hands-off approach, I am not sure things would have been better. The IMF did not create the economic weaknesses which left Indonesia vulnerable to a financial crisis in the first place, nor the country’s personalised form of government, which made responding effectively to the crisis so difficult. The IMF certainly made mistakes in assembling the stabilisation packages in October 1997 and January 1998, but these were not, in my view, the main determinants of the crisis. Far from it.

Could things have been better? Certainly some public relations could have been undertaken to forestall capital flight after the bank closures were announced in October 1997. But this was something the Indonesians needed to do, not the IMF. At any rate, the bank closures did not work because Suharto’s children were reopening those banks under different names within two weeks. Everyone knew that the people who owned the closed banks were far more politically powerful than the Central Bank as regulator. So they had strong suspicions that legal lending limits and other legal requirements were not being respected and, as it later turned out, all the suspicions were absolutely right. It is not right to pin the blame for this on the IMF.

One little discussed aspect here is the role of Suharto’s economic technocrats. They well knew about the structural deficiencies and the damaging roles played by Suharto’s cronies but were not politically strong enough to stop these activities. But the financial crisis presented an opportunity for them to address some of these deficiencies. The IMF did not on its own come up with the list of 50 structural reforms which formed the heart of the January 1998 stabilisation package. That list was very similar to the technocrats’ wish list of things they would have liked to do but could not do for political reasons. Understandably, the IMF relied heavily on the technocrats for identifying the key reforms to extract Indonesia from crisis.

In sum, when you look back at the financial crisis in Indonesia, you cannot separate it from the political crisis. After October 1997, it became increasingly unlikely that Indonesia could solve its burgeoning crisis through financial measures alone.

A lot has changed in Indonesia, but would it now be able to ride out a similar crisis? What key political and economic challenges will Indonesia still have to address?
Economically, Indonesia has struggled to return to pre-crisis growth levels. For example, it has not benefited as much as it could have from the global commodities boom, which should have drawn far more investment into its oil, gas, nickel, copper and gold mining industries, among others. On the contrary, Indonesia has gone rapidly from major oil exporter to net oil importer. The decentralisation programme is partly at fault here. The regions do not have the capacity in terms of government institutions that the central government has to exploit these economic opportunities. Additionally, Indonesia has a long way to go in strengthening laws and policies to promote economic development—there remain many statutes on the books that deter legitimate businesses and scare away capital.

But Indonesia ten years on is a lot less vulnerable to the kind of financial crisis we saw in 1997 and there are several things to note in this respect. First, there is greater transparency in the system. We know more of what’s going on, probably not quite as much as one would like, but certainly a lot more than we did pre-crisis. Second, economic institution-building is underway. There is an oil and gas sector regulator, a telecommunications sector regulator and a strengthened capital markets regulator. A strong law preserving independence for the Central Bank was passed.

Third, the gradual transition to direct elections at the national, provincial, district and municipal levels is building more transparency, accountability and trust into the political system, even if progress is far slower than many Indonesians would like. And, finally, the anti-corruption campaign of the current president, Susilo Bambang Yudhoyono, has finally begun to make inroads into an important problem that has bedevilled Indonesia since its independence. Ten years post-crisis, Indonesia’s economy is a lot less flashy but considerably more stable.

Adam Schwarz is an Associate Partner currently based in the Singapore office of McKinsey & Company, the management consultancy. Schwarz is a regional specialist, with almost 20 years’ experience working in Southeast Asia and China, including Indonesia, Thailand, Vietnam, Singapore and Hong Kong. He has served several of McKinsey's public-sector clients in Indonesia and elsewhere in Southeast Asia on issues ranging from economic policy, organisational change and post-disaster reconstruction. He is currently leading a large-scale corporate transformation programme with a major natural resources company in the region. For the ten years leading up to early 1997, Schwarz was a correspondent for the Far Eastern Economic Review in different Asian countries, covering a broad range of business, financial, political, and economic issues. He is author of the highly acclaimed study on contemporary Indonesia, A Nation in Waiting: Indonesia’s Search for Stability (Westview Press, 1999). This article was extracted from an interview conducted by Premarani Somasundram, Principal Researcher, Centre for Governance and Leadership, Civil Service College on 10 September 2007.

Page 1 I 2