Global Policy Forum

By Smitha Francis

On January 21st, 2003, Indonesia's government, under pressure from legislators, declared that it wanted to break free of its commitments to the IMF. Chief Economics Minister Dorodjatun Kuntjoro-Jakti told an annual meeting of donors that the government did not want to extend the existing $4.8 billion loan package with the Fund. This credit line under the Extended Fund Facility (EFF), of which up to $3 billion has already been disbursed, is scheduled to expire at the end of this year. The announcement came one day after the government rolled back its most recent price increases on utilities- a key plank of the economic reforms agreed with the IMF, after a two-week long nationwide protests.

On January 1st, the government of President Megawati Soekarnoputri had raised the prices on fuel (22%), telephone (15%) and electricity (6%). These price increases had everything to do with the government's commitment under the Fund program to cut state subsidies and narrow the budget deficit. After the utility prices were raised, protesters hit the streets almost daily against the 18-month-old government. Subsidy cuts combined with inflationary pressures have hurt impoverished Indonesians the most. Inflation touched 10 percent last year and the government forecasts a 9 percent rate this year. In a country where more than half of the population of 220 million live on less than $2 a day, and with more than 40 million people unemployed, these subsidy cuts hurt.

Thus, the protests continued despite a government proposal to indefinitely delay the increase in telephone charges, which the demonstrators said would not help the poor. Clearly, when only three percent of Indonesians have fixed telephone lines, delaying the phone charge increase was not going to have any impact; it was the fuel and electricity price hikes that were more severe. However, the World Bank - whose backing was vital for Indonesia to win nearly $3 billion in financial aid at a donors' meeting to be held the following week - threw its weight behind the government, saying the price hikes were needed to wean the country away from hefty subsidies. Even though the popular protests were not expected to escalate into deadly riots like those that toppled former President Soeharto in 1998, the Megawati government, which faces elections next year, decided not to take any further chances and reduced the price hikes. The proposed new prices raise the cost of fuel by 6.5%, instead of the 22% increase put in place in January. This backing down on fuel subsidies thus prompted the government to make a decision on its IMF loans.

The decision to part ways with the IMF has, in fact, come as the culmination of years of discontent brewing within Indonesia since the East Asian financial crisis savaged the country. There had long been many in the various Indonesian governments who resented what they saw as meddling by the IMF and the World Bank in policymaking, and there have been several battles of will between the IMF and the Indonesian government over the implementation of painful anti-poor structural adjustment' measures, amidst increasing protests by the people. This had led to the country's highest legislative body, the People's Consultative Assembly (MPR), urging the government in October 2002 to stop its cooperation with the IMF. In fact, it issued a decree requiring the government not to extend the current IMF programme when it expires late this year, as it believed that the Fund could not do much to overcome the country's economic crisis. After being "nursed" by the IMF for five years, the Indonesian economy was getting worse because the "recipes" given by the IMF proved ineffective. It was suggested that it would be better for Indonesia to overcome the economic crisis on its own by making optimum use of its capacities.

It was in October 1997 that Indonesia's recent tryst with the conditionalities-attached IMF loans began, when the government had turned to the IMF for an emergency debt package totalling $43 billion. This was soon after its currency began sliding following the dramatic reversal of capital flows into the country, itself triggered by the "contagion effect" that followed the devaluation of the Thai baht in July 1997.

Under its first three-year US$5 billion Extended Fund Facility to Indonesia, the IMF prescribed its now much-maligned tight macro-economic formula: i.e. strict monetary policy to stabilise the exchange rate and a tight fiscal stance to reduce the fiscal deficit. Interest rates were immediately increased in order to stabilise the rupiah. However, despite the IMF's intervention, the high interest rates failed to influence the exchange rate to any significant degree, as capital outflows continued. Further, the high interest rates led to a severe liquidity crunch. As the economy went into contraction, there was a rapid rise in company closures and unemployment. While the Soeharto government maintained that the rapid spread of poverty made increased subsidies on items such as food and fuel essential, financial markets construed President Soeharto's failure to embrace fiscal austerity in the January 1998 budget as a reflection of the inability of the IMF to enforce discipline on the government. This led to further collapse of the rupiah, driving about 75% of Indonesian businesses to technical bankruptcy due to the large foreign debts they had accumulated over the period of financial liberalisation prior to the crisis. In this increasingly desperate situation, true to its tradition, in a new Letter of Intent (LOI) in January 1998, the IMF secured a greater number of even more stringent reform commitments than in the October LOI. However, the introduction of this second package of IMF reforms also did not lead to any immediate stabilisation.

The January agreement included sweeping reforms including the dismantling of state and state-enforced monopolies, elimination of consumer price subsidies, phasing out of utility subsidies, and further trade and investment liberalisation. Specific steps to liberalise trade and investment included: reducing tariffs on all imported foodstuffs products to 5% and cutting non-agricultural tariffs to 10% by 2003; opening banks to foreign ownership by June 1998; and lifting restrictions on foreign banks by February 1998. Since the start of the loan program, the IMF has also persistently pushed the Indonesian government to further open its economy through various programmes like: the elimination of monopolies and cartels; reform of the wood sector; privatisation of state-owned enterprises (SOEs); and downsizing of the National Logistics Agency (BULOG). As the International NGO Forum on Indonesian Development (INFID)[i] has argued, the IMF have been constantly demanding rapid reforms, including quick sales of the Indonesian Banking Restructuring Agency's (IBRA) assets and the privatisation of hundreds of state-owned companies, regardless of the capacity of the state to carry out the reforms in the time periods envisioned and the long-term impact of these programs on the Indonesian economy or the poor. Each time there were any perceived delays in implementing any of the crucial' measures which the country had committed to the IMF in the Letters of Intent, the Fund delayed its country review, on which the next tranche of IMF funds as well the bilateral loans (i.e. from lenders in the CGI belonging to the Paris and London Clubs) were hinged. These IMF interventions have resulted in the Indonesian economy being the worst affected among the five East Asian crisis-hit economies.

Prior to the 1997-98 financial crisis, Indonesia had a relatively comfortable debt situation. The government borrowed primarily from the World Bank, Asian Development Bank, and a group of bilateral donors grouped in the Consultative Group on Indonesia (CGI), for funding its development budget. Establishing this as a convention, government avoided domestic borrowing, and Indonesia's debt/GDP ratio was considered sustainable by the multilateral bodies and other donors. Following the oil price crash in the early eighties, Indonesia undertook banking and financial sector liberalisation, without adequate prudential protection of its system. While its debt management policies were considered adequate, its financial liberalisation, which exposed the Indonesian economy to the 1997 currency crisis was, until then, considered a successful experience.

The situation changed in 1998-99, when Indonesia for the first time contracted a large volume of domestic debt to finance the bailing out costs of the country's crisis-hit banking sector. The bailout was necessitated by the crisis that occurred despite a decade of ostensibly successful WB/IMF promoted financial liberalisation, and because of the fact that the Indonesian government had followed the IMF advice to immediately restructure its crisis-hit financial sector. With at least 70 percent of bank loans estimated to be non-performing following currency devaluation and the financial crisis, at the direction of the IMF in November 1997, the Government had closed 16 insolvent banks without adequate preparations. The result was the near-collapse of the entire financial system, which in turn forced the Government to re-capitalize the banking system by issuing bonds to domestic commercial banks and the central bank. This created an estimated US$80 billion in new domestic debt, even as the successive governments after Soeharto also inherited the substantial foreign debts accumulated during his time. As a result, Indonesia's official debt burden increased from 27 per cent of GDP prior to the crisis to more than 100 per cent by the end of 1999, before declining gradually. In fact, Indonesia, which was ranked as middle income and middle indebted before the crisis (at the same level as its neighbours Thailand and the Philippines), has come to be ranked as belonging to the SILIC (severely indebted low income countries) category, while none of the other crisis-hit East Asian countries such as Malaysia, Thailand and Korea are in the SILIC group.

The IMF has refused to take any responsibility for the way its wrong policy advice exacerbated the crisis and stalled the subsequent recovery. Further, instead of providing any long-lasting solution to the debt burden which they themselves helped create and accumulate, the multilateral bodies and bilateral donors have continuously insisted on policy measures requiring stringent constraints on expenditure and increased revenue mobilisation, for servicing this sharply increased debt burden. This has continuously crippled the capacity of the Indonesian government to mitigate the impact of the crisis on vulnerable groups. From an estimated 9.6 percent in 1996 - the year before the Asian financial crisis - Indonesia's poverty rate had doubled to 19 percent in 2001. The government has sought to support the increased number of people who have fallen below the poverty line with three kinds of measures: 1) temporary income transfers, through rice distribution to the poor at subsidised prices; 2) income support, through employment creation and by support for SMEs and co-operatives; and 3) preserving access to critical social services, particularly education and health.[ii] Nevertheless, most of the government efforts to mitigate the impact on the poor have been limited by severe budget constraints. According to Bank Indonesia data, in 2001, total amortisation and interest payments on Indonesia's domestic and foreign debt had reached almost 35 percent of central government expenditure. INFID (2001) estimated that the total amount of the government's debt service would have increased further to around 38.7 percent of total spending for 2002. By way of comparison, critically needed development spending declined from about 45% of total government expenditure in 1993 to 33% in 2001, where more than half of this sum stemmed from donor-financed development projects. As per INFID (2001 and 2003), social spending also suffered a dramatic decline, around 40 percent in real terms below the spending in 1995/1996.[iii]

Meanwhile, notwithstanding the economic fallout from the October 2002 Bali terrorist attack, the 2002 budget deficit is estimated to have fallen to under 2 percent of GDP, down from 3.6 percent of GDP in 2001. The windfall export earnings due to the oil price rise contributed in a major way to this. The year 2002 also witnessed a large reduction in Indonesia's public debt burden. The public debt-to-GDP ratio fell from about 90 percent at the end of 2001 to almost 70 percent by the end of 2002. Apart from the continuous reductions in government spending, this has been achieved through major government disinvestment programmes and privatisation. After the recapitalisation of the private banks, the IMF has exerted strong pressure on the government to divest the assets it held in the form of the banks' shares. The Indonesian Bank Restructuring Agency (IBRA) has now disposed of over half of the original portfolio of NPLs taken over from weak and closed banks. In 2002, the government also sold its majority stakes in two banks and in the international telecommunications company-Indosat. In fact, the government exceeded its 2002 privatization target of Rp 6.5 trillion, collecting Rp 7.7 trillion. However, according to INFID (2003), this divestment has produced only relatively small revenue compared to the high costs of servicing the government bonds that had been issued to recapitalise those banks. Further, the privatisation program particularly the sale of state-owned enterprises and assets while simultaneously retaining the debt has aggravated the domestic debt burden.

Meanwhile, the external debt stock has also fallen from its peak at the end of 1999. However, as the Figure reveals, annual debt payments until almost 2000 were achieved through swapping of funds across the available channels of raising funds. But, since 2000, the trends in all the liabilities (total liabilities to banks, trade credit, claims on banks, multilateral and bilateral claims) have turned negative, reflecting the mounting debt repayment and servicing obligations for the country. It is thus evident that the economy would continue to face a severe liquidity crunch as outflows continue. Even though Indonesia had sought rescheduling from the Paris Club in 1998, 2000, and 2002, these agreements are only for bilateral debts and exclude debts to private bondholders as well as multilateral creditors. Moreover, the rescheduling excludes the best terms (including partial write-offs) available under the Paris Club conditions. Further, the enforcement of the Paris Club agreement is conditional upon the progress of the program laid out in the government's letter of intent to the IMF. Meanwhile, despite its low income and SILIC status, the IMF and the World Bank consider that Indonesia does not qualify for debt relief under HIPC.

The IMF and the World Bank's assessments that Indonesia's debt is sustainable are compromised by misleading and over-optimistic assumptions about Indonesia's growth rate, as well as by their status as creditors. According to the latest estimates from the Central Statistics Agency, GDP, investment and export growth fell in 2002. According to Bank Indonesia data available till March 2002, net private capital inflows that turned negative in end 1997 have also remained negative ever since. Another report has stated that while all the ASEAN countries have registered positive growth in FDI, Indonesian FDI inflows have failed to recover. An American-led attack on Iraq could further hurt investment in Indonesia, with the world's largest Muslim population. A war in the Middle East is expected to send shipment costs soaring by more than a third and further erode cost competitiveness. Meanwhile, with a significant drop in tourism expected due to concerns about internal security following the Bali attack and considering the effects of a slowing global economy since the previous forecast, growth in 2003 is forecast to be about 1 percentage point weaker than previously foreseen, or down to 3.5-4 percent. On the other hand, while the share of oil and gas exports in total Indonesian exports shows a decline from 31% in 1992 to about 22% in 2001, the share of oil and gas imports in total Indonesian imports rose from some 10% in 1992 to 18% in March 2002. Under these circumstances, the prospects for servicing both the existing foreign and domestic debts would remain a huge burden on the country's development expenditures for the perceivable future, even without taking on new debt.

Those co-responsible for the creation of Indonesia's unpayable debts - G7 creditors, the IMF and World Bank - do not bear the financial risks associated with the loans they made to Soeharto, even as they continue to blame cronyism and corruption and seek legal and corporate reforms. In spite of the fact that a large chunk of this public debt in effect arose from their own misguided advice to the Indonesian government, the IMF and the CGI persist with their insistence on the continued reduction of Indonesia's large public debt. It is clear that most of the costs arising from the failure of IMF/WB-supported liberalisation of Indonesia's financial market and the malfunction of the banking system have been transferred from private financial institutions - whether domestic or foreign - to the Indonesian public. This apportioning of costs between the public and private sector has highly inequalising consequences. At one level, the combination of the credit squeeze (the fact that the mandatory capital adequacy ratio was increased to 8 percent last year as part of the Government's program to strengthen the banking system, also contributed to the credit squeeze), falling government expenditure on development purposes, and the increasing role of private sector in public utilities with collusive pricing behaviour has led to unacceptable falls in the disposable incomes of the Indonesian consumers. However, the inflexibility of the IMF in its fiscal deficit targets has made it difficult for the government to maintain subsidies at levels commensurate with the falling income levels. At another level, the global economic slowdown, the uncertainties associated with the current conjuncture and the lack of international liquidity means that there are very poor prospects for a quick resumption of export growth or of private capital flows into the country. Thus, by deciding not to extend the IMF loan, the Indonesian government has climbed out of the tough fiscal austerity measures prescriptions that have been hurting millions of its poor.

Meanwhile, after the initial uncertainty, Jakarta's donors under the Consultative Group on Indonesia (CGI) have signalled that they would give the nation the $2.6 billion aid it wanted for 2003, despite the fuel price back down. Clearly, the reality is that Indonesia is probably too big and important to fail as the Economist has conceded very candidly. The IMF and the World Bank - key proponents of raising prices on utilities to cut costly subsidies have now agreed that Jakarta's back down has to be viewed against the fact that the social unrest was not desirable and risked derailing what had been accomplished thus far. The World Bank, which is leading the group's negotiations, had warned Indonesia earlier that resuming subsidies might jeopardize requests for new loans. Apart from being a big country, the fact that Indonesia has been afflicted with political instability and Islamic fundamentalism has also become a factor influencing the external decision making process, especially in the face of the 2004 elections. Indonesia, though an ally of the US in the global war on terrorism, opposes military action in Iraq. In the current conjuncture, the donors are acutely aware of the danger of social unrest in the world's most populous Muslim nation, which has been buffeted by five years of turmoil since the 1997-98 Asian economic crisis. This is why while earlier pleas that the Indonesian government is unable to repay its debt without imposing unbearable hardship onto the poorest sectors of society fell on deaf ears and the government was persistently made to undertake drastic measures, the present turnaround by the Indonesian government is seen justifiable.

While recently, in many of the debt-ridden countries, social and political unrest primarily caused by conditionalities-imposed economic hardships has come to be seen by the World Bank-IMF institutions as derailing the "hard-won" financial stability in those countries and have then allowed some flexibility in the reform measures demanded of these countries, clearly the desirable thing would be to avoid in the first place the ideological prescriptions which lead to such mass suffering. At another level, shouldn't the multilateral bodies, which are linking up their aid and loan packages to democracy-linked electoral reforms in these countries, be looking at popular protests as indicators of increasing political participation by the affected population in these countries? Apart from the democratic reforms, it is indeed interesting to see that the Bank and Fund-advocated decentralization, which on the whole is acknowledged to have proceeded relatively well, is now being perceived by them as a new problem for both existing businesses and prospective investors, in the form of new and conflicting regulations and taxes at the regional level.

It has been seen time and again in East Asia, Latin America (with Argentina having seen the most recent devastation) and elsewhere that the IMF-World Bank programs driven by an absolutist ideology do not work at all in crisis scenarios and in fact make them worse. But, it has also been seen that there is very little scope for these leviathans to change their course when confronted with the crises, failures, and suffering perpetrated by their misguided policies until the consequences appear to affect the interests which they themselves represent. In a recent instance of reversal of stance, four years after describing Malaysia's decision to peg its currency to the dollar during the financial crisis in 1998 as a "retrograde step," the IMF has said that the peg is an "anchor" of a rebounding economy.[iv] In a December 2002 report, the Fund has said that Malaysia is better off for having ignored its advice. Clearly, other East Asian crisis countries that followed the Fund advice are not going to benefit at all from this admission of the IMF. Further, despite such pronouncements at convenient times, the Fund continues to impose the same set of macroeconomic prescriptions on countries facing a payments crisis. For instance, under an interim agreement reached after a year of negotiations, the Fund agreed to roll over, or reschedule, about $6.8 billion in Argentine debt that is due through August. But, it is feared that even the modest terms imposed as part of this would include imposing sharply higher utility rates, creating bigger budget surpluses and severely restricting the amount of money in circulation, all of which will further deteriorate the prospects for economic recovery there. Thus, apart from being delinked from their financial responsibilities in taking on the risks of their sovereign credits and perversely gaining from major policy errors and go on to compound them, the Fund has again demonstrated that it has no moral responsibility also.

Against this backdrop, Indonesia's decision to finally ask the IMF to go packing rather then continuing to fall down on the path to utter deprivation for its citizens, clearly seems the most rational' choice to have been made. This has come as the latest instance where a number of countries, including Botswana, have either opted out of the IMF programs or refused to initiate the Structural Adjustment Programme (SAP). This clearly is reassuring and holds promise for encouraging further such rational' choices to be made by countries facing neo-liberal reform pressures. This would also promote countries to turn towards addressing their domestic socio-economic problems.

But, in the final analysis, it is important to see that small developing and least developed countries do not get left out in the geopolitical power games. While these individual initiatives by large developing country borrowers have immense significance on their own, across the South, the struggle for forcing broader and deeper changes in the parameters within which the multilateral bodies operate, must continue.

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