October 6, 2007

INDONESIAN FINANCIAL CRISIS AFTER TEN YEARS:

SOME NOTES ON LESSONS LEARNED AND PROSPECTS

J. Soedradjad Djiwandono
Professor
S. Rajaratnam School of International Studies
Nanyang Technological University, Singapore
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INDONESIAN FINANCIAL CRISIS AFTER TEN YEARS;

Some notes on lessons learned and prospects*

J. Soedradjad Djiwandono@

INTRODUCTION

There have been so many books and articles and reports as well as conferences and
seminars discussing what have happened a decade ago in the economies of Asia, the
causes and effects, descriptions and analyses as well as lessons learned or not learned
together with attempts to theorize of what generally labeled as financial crisis. Curiously,
there is no standard interpretation yet as to what causes the Asian financial crisis, except
on few things, like that it was triggered by a rapid depreciation of the Thai baht on July 2,
1997. This may explain why aside from the obvious reason of its tenth anniversary there
are tremendous interests for revisiting the discussions on the subject in different places,
especially in looking at what governments, business communities and regional as well as
multilateral institutions or the stakeholders could learn or unlearn from the past to avoid
its repeat in the future and to cope with it better if new one arises.

But, discussing about what happened a decade back about complex matters like the
financial and economic crisis is not an easy thing. For Indonesia, the challenge is even
bigger because the crisis has been very complex indeed and in a way it is a unique as I
would discuss below. In addition, I would conjecture that as a nation Indonesia has so
much difficulty to face and be at peace with its own past. Writing about the Indonesian
crisis, which is a historical event is therefore difficult.

However, it is precisely because of those that after ten years it is still relevant to talk
about the Asian financial crisis, even reminiscing about how it happened and speculating
about what actually had been the causes. This is a discussion about the already much
discussed past of events, so I will highlight only the areas that in my view need
straightening out or correction. This is what this paper is about; an Indonesian insider’s
view of the Asian crisis. It will start with a descriptive analysis of what happened,
looking and the similarities and differences of what seem to have been the causes of the
crisis in different countries, Indonesia in particular. The description will also include the

*
Presented at the conference Ten Years after the East Asian Crisis: Lessons and Future Economic
Prospects, Waseda University, Tokyo. This paper is originally presented at the conference The Tenth
Anniversary of the Asian Financial Crisis, organized by the Woodrow Wilson Center, Washington DC,
16/05/07.
@
Professor, S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University
(NTU), Singapore.
 2

initial policy responses by the government, through regional cooperation and the
International Monetary Fund (IMF) support. It concludes with some speculation on
whether we are facing the repeat of the crisis as a conjecture of whether lessons from the
crisis have been learned.

HOME GROWN BUT NOT HOME ALONE

It is instructive to look at the similarities of how crisis developed in different economies

in Asia as well as comparing them with other cases outside Asia both before and after the
1997/98 crisis. However, it may even more important to recognize their differences,
including the policy responses of the stakeholders, the effects of the crisis in respective
cases and the lessons learned and not learned by them. Let me mention some of the
findings that others made regarding these issues, in particulars those that either adding to
or correcting the past studies, which in a way become standard interpretation. One which
I found learning from these studies has been that the differences of one crisis from
another seem to be more prominent than the similarities. In other words, crisis seems to
be more country specific, even though we could find certain pattern in some of the
characteristics.

In terms of its sequence the Asian crisis started with rapid Thai baht depreciation in July
2, 1997, which was followed with a contagion, spreading it to other currencies in the
region. However, there is a characteristic, which only recently showed by Ito (Ito, 2007)
that first, in terms of the speed of the currency depreciation the Asian contagion
proceeded much slower to what happened with the pesos in the Mexican crisis of
December 1994. Secondly, Ito showed that the leading country in terms of currency
depreciation - what he called the epicenter of the crisis – had moved from baht (July to
September, 1997) to rupiah and won (September 1997 to January 1998). Since January
1998 rupiah was the epicenter. After the Asian contagion the crisis erupted in Russia
(1998), Brazil (1998-1999), Turkey (2000-2001) and Argentina (2000-2001).

Despite the consensus on the contagion that the Asian crisis affected most economies in
Asia, after months of its development the currency depreciation was different between
countries suffering from the crisis. By September 1997 there were four groups of
countries in terms of the dept of the depreciation to their respective currencies. Ito (Ito
2007) showed that there were four classes in terms of the intensity of the depreciation.
Thai baht suffered the most, followed by Malaysia, Indonesia and the Philippines,
followed later by Singapore and Taiwan who had mild depreciation. Meanwhile, China
renmimbi and Hong Kong dollar were not suffering depreciation, the first one due to the
capital control, while the second one due to the peg system supported by currency board.

After the crisis, most Asian currencies have been strengthened, but only to the levels less
than their pre-crisis. The appreciation of currencies has not been similar for all currencies.
Ten years after the crisis the Korean won and Singapore dollar recovered 90 to 95 per
cent of their respective rates. The Thai baht and the Malaysian ringgit recovered 70 per
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cent of the pre crisis levels, the Philippines pesos 50 per cent, while the Indonesian rupiah
25 per cent.

All Asian economies, except China have also recovered their economic growth rates,
however their growth of GDPs ( 4 – 6 per cent) are lower than the pre crisis level (7 – 9
per cent) and associated with them the investments rates have also been lower than the
pre crisis levels.

The immediate issue associated with the above has been the question of undervalued
currencies, which ones, by how much and what to do about them. Furthermore there has
also been issue of whether the pre-crisis growth (and investment rates) is the normal
pattern or the ones after the crisis. And the implications has been the debate on the saving
gluts and investment deficits or excessive spending and lack of savings is the correct
explanation for the problem existence of global imbalances (Bernanke, 2005, Rajan, 2006,
Wolf, 2007).

With a view to the already so much discussions and theories about the causes or the
process of how the 1997 Asian crisis developed, it has been my contention that the
Indonesian crisis was triggered by an external financial contagion, i.e. the rapid
depreciation of the Thai baht in early July 1997, almost immediately after its floatation.
When the contagion hit Indonesia’s finance it ushered in a different type of contagion;
from foreign exchange market crisis to banking in distress and banking crisis, on to
economics and ultimately socio-political crises, which culminated in the fall of the 32
years reign of Soeharto in May 1998.

In the case of Indonesia the crisis came up due to two important factors, a contagious
shock, which hit the institutionally weak national economy. Thus, there are two critical
elements that ultimately transforming financial shock into a contagion. First, Indonesia’s
crisis is triggered by a financial shock in the form of contagious external currency
depreciation. It is implies here that the Thai baht rapid depreciation was contagious and it
served as the triggering factor to the ensuing crisis. It is my contention that the trigger
must be contagious. However, it does not have to be financial shock like rapid
depreciation of baht. It is also my contention that the trigger could come from other
factors, either shock in economics, finance or socio-politics. If the shock is not
contagious a crisis may not develop. In January 1995 Indonesia experienced a currency
shock originating from the Mexican’s crisis, which caused the currency (rupiah) to
depreciate fast. But, it was easily stabilized by way of Bank Indonesia’s intervention – of
close to USD 600 million, supported by the tightening of monetary stance and the
widening of the intervention bands in a managed floating framework. This is a financial
shock, which does not develop into contagion, and no crisis develops. Second, the
contagion hit Indonesian economy, whose institutions were embedded with structural
weaknesses, i.e. the banking sector, the corporate sector, and the socio – politics and their
governance. In this environment the trigger from the financial sector in effect brings out
the weaknesses into the open and the whole systems were exposed to destructive attacks.
Indonesia also suffered another currency shock in July 1996, which originated from
social unrest after Megawati Party’s headquarter was ransacked. The rupiah took a
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beating, but Bank Indonesia successfully stabilized the currency before it developed into
a contagion. Of course the intervention cost Bank Indonesia another USD 700 million of
market intervention. (Djiwandono, 2005)

The basic difference of the arguments and theories about the Asian crisis basically
centered to the question of whether the causes of the crisis originated domestically, as
weak fundamentals, cronyism and faulty policies or externally, like abrupt perception
change that trigger capital flow reversal, exacerbated with herd instinct mentality in
financial market. It is my contention that the Indonesian crisis is caused by a combination
of external shock and domestic institutional weaknesses, and complicated further by
inconsistencies of responses from the stakeholders; the government, the private sector
and the International Monetary Fund (IMF or the Fund) after its involvement. I like to
use the phrase “home grown, but not home alone” to describe the causes and the process
of the Indonesian crisis of 1997/98.

AN INDONESIAN CRISIS

In spite of the fact that what happened in the economies of the region is indeed a part of
the Asian contagion I would argue that over time and with more careful assessment of
what happened one would find more differences of countries’ experience such that the
Asian crisis could be considered country specific. I would even go further to say that
despite the fact that Indonesia’s crisis is definitely part of the Asian contagion, it is also
unique.

Recently the academics are still debating on how to explain this phenomenon. It is also
curious to note that recently the debate also turned to different direction. In the midst of
rampant domestic dissatisfaction about the slow process of reform and recovery, some
have been pleasantly surprise to notice that Indonesia actually experienced negative
growth rate only in 1998. Since then it has been steadily growing to the present growth of
close to 6 per cent. The pleasant surprise came from the fact that this has been achieved
together with the democratic process in politics, which runs well. As some argued, even
though all crisis countries have experienced political changes, Indonesia’s experience has
been the most substantial (Hill and Shiraishi, 2007).

Both the similarities of Indonesia’s initial conditions with other crisis countries as well as
its worst position immediately after the crisis could be seen from the two tables below.
From the list of vulnerable indicators the ratio of short - term debts to GDPs, the non-
performing loans in banking or the current account deficits of the crisis countries are
similar. In some indicators, like current account deficits Indonesia’s is even better. May
be the indicator of company ownership as a proxy of cronyism is the only sign which
definitely shows Indonesia’s has bigger concentration of ownership in comparison to the
others. And the second table clearly shows that Indonesia suffers the worst in terms of the
immediate impacts of the crisis as shown from the figures of the negative GDP growth,
the currency depreciation and the performance of the capital market.
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The Indonesian crisis is in a way unique that despite exhibiting similar initial conditions
or vulnerabilities with other crisis countries – Thailand, Korea, Malaysia and the
Philippines - and generally recognized as coming up with prudent policy responses
initially, it ultimately became a basket case; suffering the worst and taking the longest
time to recover. At present, ten years after the crisis most Asian economies with the
exception of China, still exhibiting lower economic growth rates and lower level of
investments compared to the pre - crisis levels. Despite much improvement after the
crisis exchange rates of the Asian currencies are still worse than pre-crisis. Indonesia
also experiencing continuing improvements, however, it has been performing worse
among the former crisis countries in most aspects of the above.

Table 1

VULNERABILITY INDICATORS

Indonesia Korea Thailand Malaysia

Dom Debt/GDP 50 50 87 82
(92-96)
Corp Debt/Equity 190 480 170 90
1991 200 640 340 200
1996
Family controlled 67.3 24.9 51.9 42.6
Cos
State Cos 15.2 19.9 24.1 34.8
Bank Credits 12 15 37 38
(92-96)
Property loans 25-30 15-25 30-40 30-40
NPLs 96 8.8 0.8 7.7 3.9
(98) 40 20 34 19
ST Debt/Res 188.9 217 121.5 45.3

Export (96) 9.1 -2.8 -4.5 0.9

Cu Acc 91-95 -2.4 -1.8 -7.7 -7.6
Cu Acc 96 -3.2 -4.4 -8.9 -4.4

Source: rearrangement of Table 2, Asian Crisis Countries: Vulnerability Indicators, Andrew Berg, “ The
Asia Crisis: Causes, Policy Responses, and Outcomes”, IMF Working Paper no. WP/99/138, p. 8 and table
5, Assets of Corporate Relations with Banks and States, Qaizar Hussain and Clas Wihlborg, “Corporate
Insolvency Procedures and Bank Behavior: A Study of Selected Asian Economies”, IMF Working Paper,
WP/99/135, October 1999.
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Table 2

IMPACTS OF CRISIS
(June 97-March 98, percent changes)

Indonesia Korea Thailand Malaysia

Nominal ER -75 -41 -38 -33
Real EER -63 -33 -27 -23
Nominal IR 32 12 8 3.5
GDP growth -13.7 -5.8 -9.4 -6.7
Stock Mkt ($) -50 -46 -58 -79
Stock Mkt (local -27 -38 -18 -38
cur)

Source: Adapted from Table 5, Andrew Berg, ”The Asia Crisis: Causes, Policy Responses, and Outcomes”,
IMF Working Paper, No WP/99/138.

Some argued that Indonesia faired the worst in the crisis due to the government policies
together with Bank Indonesia, the central bank that were faulty. This argument is either
unfair or incorrect. Many policies and steps were adopted by Bank Indonesia, both as part
of and independent from the Government of Indonesia’s efforts to address the crisis and
beyond. Some of the prominent policies to address the crisis include the decision to free
float the rupiah in mid-August 1997, the policy to provide liquidity supports to all banks
suffering from liquidity mismatches, the closures of 16 banks in early November 1997,
and the debate on the possible introduction of rupiah peg with a currency board – the
popularly known as currency board system (CBS) in January 1998.

The government decision to free float the national currency in August 14, 1997 caught
the Indonesian business community off-guard. It was hailed by many as pre-emptive
when it was issued, but it was also blamed by others as unwarranted. The currency was
depreciating rapidly afterward, partly due to the business and public responses to the
government policies to address the crisis, which included the action by business
community to buy dollar either to cut loss or fly to safety for their financial assets. The
government and Bank Indonesia’s policy to tighten fiscal and monetary stance that
followed had triggered the domestic contagion. And thus a contagion developed from
currency shock to banking in distress and crisis and economic crisis there after as banks
and corporate sector collapsing through the balance sheet effects. With the benefit of
hindsight the doubling of interest rates by the central bank on its certificates (Sertifikat
Bank Indonesia or SBI), the government instruction for state banks to transfer their
deposits to central bank certificates and the curtailment of budgetary routine expenditures
that were meant to strengthen the exchange rate in a situation of banks in distress were
indeed too stringent. This may explain why the policy fails.

The decision to invite the International Monetary Fund (IMF) in early September 1997
was made with the aim at propping-up market and public confidence on the economy and
the management of the economy. This is in recognition of the fact that Indonesia was
facing a global finance in the region such that the presence of the multilateral institutions
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was hoped to help raising the market confidence. One of the programs in the Indonesian
case was for the government to implement a comprehensive bank restructuring, which
included closures of insolvent banks. In fact, the bank closure became a prior action
program, which served as a precondition for the IMF to agree on providing a stand-by
loan.

Unfortunately for Indonesia, the bank closures were not just failing to bring back market
confidence they even triggered bank runs and brought the banking sector near total
collapse. It turned out that the bank closures with tightening monetary and fiscal stance
on top of the steps simultaneously applied to tighten monetary and fiscal stance
previously were like pushing distressful banks into a real banking crisis.

There have been many discussions on the merits and demerits of the bank closures,
including who are to blame as in other issues. On the debate of why the bank closures did
not succeed different arguments have been raised. Many argued that the bank closures
failed because Indonesia did not have deposit insurance when the closure was made
(Radelet and Sachs, 1998). Others argued that more banks should be liquidated
(Goldstein, 1998). I do not agree with the argument about the absence of a deposit
insurance scheme as the culprit. Most deposit guarantee schemes only cover small
depositors, which Indonesia provided at the time of the closures. The problem arose from
the big depositors, not from small ones, which a normal deposit guarantee scheme would
not cover. It seems plausible that, if only Indonesia introduced an overall guarantee as
the one introduced toward end of January 1998 (blanket guarantee), the bank closures of
November 1997 might not cause bank runs. I should add that if only all owners of the
liquidated banks were behaving well, instead of protesting the closures by waging public
campaign criticizing the bank closures policy and suing the Minister of Finance and Bank
Indonesia Governor to court, bank runs might be avoided.

The most controversial policy was the provision of Bank Indonesia liquidity supports
(BLBI) to banks experiencing liquidity mismatches during the crisis. It was controversial
in several aspects. This policy cost the bank restructuring to be estimated at close to 50
per cent of the nation GDP, the highest among the crisis countries with huge public
money loss to finance it. Furthermore, the policy has been associated with cases of
corruption of officials and bank owners. Even to day, the public perception has
predominantly been that BI liquidity supports have been a mistake, which has been
unfairly put the burden to the tax payers, and that the onus is Bank Indonesia, which
introduced the policy. For sure, there have been corruption cases involving bankers.
Three of my colleagues all former Bank Indonesia managing directors were jailed,
curiously not for corrupting money but for violating internal measures and acting
imprudently in the decision to provide BLBI. The story has not come to a close yet, and
up to the present there are still accusations to Bank Indonesia officials and former
officials on the issues. BLBI has become a ‘scarlet letter’ for Bank Indonesia and its
officials.

I have been writing in different places on the issues (Djiwandono, 2004). I would only
put down some notes here. First, as the findings of the audit by the supreme audit board
 8

(BPK) showed that the total amount of the BI liquidity supports to banks up to January
1999 has been 144 trillion rupiah (close to USD 70 billion at the current rate). Some
considered this amount equivalent to the loss to the state finance, without any
consideration on the amount of repayments by some banks and the revenues from the
sales of assets of the recipient banks or even the sales of these banks themselves by the
Indonesian Bank Restructuring Agency (BPPN). Second, the public generally perceived
that the number of banks receiving the liquidity supports is only the number of banks
managed by BPPN, i.e. 54 banks. However, the actual number of banks receiving the
liquidity supports during the crisis is 130 over. But, not all recipient banks became
problem banks that have to be managed by BPPN.

Arguments have been very strong that the total amount of the liquidity supports as
mentioned before was the same as the total amount of loss. Only a few seem to go back
to economics as alternative cost concept, like what would have been the cost to the
economy had there been no liquidity supports provided to banks during the crisis. Would
the government (BPPN) still have any right to sell privately owned banks after the crisis
if there were no liquidity supports? In terms of policy, the liquidity supports for banks
provided by Bank Indonesia were completely acknowledged by the recipient banks and it
became the government claim to these banks. Would there still be 136 banks that now in
operation, which are relatively in good conditions had there been no liquidity supports
during the crisis? Isn’t there any difference between cost and loss? For sure, a thorough
analysis would have to make this distinction to be able to come up with the actual figure
of the economic and financial loss of the policy.

Bank Indonesia liquidity support for sure incurs costs and losses to our economy.
However, it is curious that almost no discussions were ever made on the cost of bank
recapitalization, which cost more than four times the amount of the liquidity supports.
And out of the total cost of bank recapitalization the biggest amount was recapitalization
of state owned banks. It is my view that the liquidity supports that the central bank
provided during the crisis and the bank recapitalization in 1999 are similar in character,
the first one is liquidity supports to help banks facing liquidity mismatch, while bank
recapitalization is to help banks facing ‘capital mismatch’ that are closely associated
with solvency problem.

On the debate about the rumor of President Soeharto’s intention on January 1998 for
returning to a peg system with the creation of a currency board and the rumor of my
disagreement with the intention as well as the perceived reasoning for my dismissal as
central bank governor should also be properly explained here. I did not support the idea
of a peg system with a currency board then. But, the main reason was the concern that I
could not see a consistent implementation of a currency board system in the current
condition at the time. It was hard to see President Soeharto would let the system went on
its course without his high propensity to intervene or tinker. A CBS is sometime called
‘an auto-piloted system’ whereby nobody should be allowed to tinker. I was also
concerned that our reserves were not sufficient to back a currency board. But, ultimately
the idea was discarded in my opinion due to the mounting pressures from leaders of many
western countries against the plan in addition to Bank Indonesia memorandum to the
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President, which basically showed that the adoption of a currency board was not feasible
at that time.

SOME NOTES ON FUTURE PROSPECTS

Have Indonesians learned from the past crisis? Actually the questions should be
addressed to all parties involved in the crisis and its resolution. Stan Fischer reminded us
just before leaving the Fund that all parties, including the national governments, the
multilateral institutions and the private sectors from lender and well as borrowing
countries have to make adjustments and reforms to in order to be able to cope with the
crisis.

With respect to Indonesia, much has been done, yet much more still have to come for the
country to be effective in avoiding a repeat of the 1997 crisis and to face new challenges.
Rather than looking at what have been done in terms of building up and maintaining
proper institutions for the policy to work effectively in avoiding financial crisis and
maintaining stability for future development of the national economy I would conjecture
that the recent development in the Indonesian finance showed that the danger of a repeat
of the 1997 crisis to happen again is insignificant indeed.

When we observed the recent phenomenon of high volume short term capital inflows as
reported in the capital market performance, including strong property development,
which have been similar to the development shortly before 1997 have raised concern of
government officials, including the Minister of Finance of a possible repeat of a financial
crisis.

However, I think a repeat of 1997 financial crisis is not highly likely at the moment since
both the conditions of the Asian economies in general as well as domestic conditions,
including Indonesia have not warrant strong motivation for market players to make
moves that would trigger a shock, which could develop into a contagion of 1997 nature.

The Asian economies have generally been in a better shape compared to the conditions in
1996/97. The most important factors have been the accumulation of foreign reserves by
almost all economies in Asia. The total reserves of East Asian economies are around
USD 3.5 trillion with China alone holds USD 1.2 trillion. Even Indonesia holds more
than USD 50 billion of reserves. The current accounts of most East Asian economies
have been in good shape. In addition, despite no standard pattern or well established
cooperation among Asian economies the exchange system in most economies in East
Asia is more flexible compared to the past, generally closer to a floating system than
fixed. With these two favorable factors in most East Asian economies I do not see there
are enough incentives for market players to make a move for profit taking that would
become a trigger a contagion.

Furthermore, the domestic conditions in terms of the banking and other institutional
structures of today Indonesia are also less prone to a contagion as compared to the pre
 10

1997 conditions. The banking sector is not as weak as in the past. The average capital
adequacy ratio (CAR) of Indonesian banks is currently around 20, while just before the
crisis in 1997 it was substantially less than the required 8. The average loan to deposit
ratio of banks in Indonesia is currently around 60%, while in 1996 it was over 80%. At
present foreign short term exposures is much smaller than the past, private sector foreign
exposures are also much less. The prudential measures and their compliance as well as
the conducts of monetary policy and the lender of last resort by Bank Indonesia have
undergone much improvement after the crisis. In addition both social and political
infrastructures are more robust now than the past. I do no see a financial shock that
strikes Indonesia to day would cause a second type of contagion that would cause
financial crisis.

Thus, from both external as well as domestic environments it is my conjecture that

despite the fact that the financial sector continues to face varieties of risks the danger of a
repeat of the crisis is not eminent. However, this should not make Indonesia and indeed
Asian economies to be complacent. The world economy is facing new and different
challenge; the presence of unsustainable global imbalances no matter how you assigned
of what have been the causes of them, which imply the presence of a huge risk for
dealing with the implications of their unwinding to name one of the obvious dangers.

The most recent financial problems, originated from the collapse of some sub-prime
mortgages are other cases that have raised valid concern that if we are ready for
addressing crisis it may be actually only for the last battle, which is no guarantee against
new challenges, which may be completely different in nature from the past Asian crisis.

REFERENCE

Berg, Andrew (1999), “The Asian Crisis: Causes, Policy Responses, Outcomes”,
IMF Working Paper, WP/99/138, Washington DC: International Monetary Fund.
Bernanke, Ben S. (2005), The Global Saving Glut and the US Current Account Deficit,
Remarks at Sandridge Lecture, Virginia Association of Economics, Richmond, Va.
(www.federalreserve.gov)
Djiwandono, J. Soedradjad (2004), “Liquidity Support to Banks During Indonesia’s
Financial Crisis”, Bulletin of Indonesian Economic Studies 40, no1, April, 59-75
Djiwandono, J. Soedradjad (2005), Bank Indonesia and the Crisis; An Insider’s View,
Singapore: Institute of Southeast Asian Studies
Goldstein, Morris (1998), The Asian Financial Crisis: Causes, Cures, and Systemic
Implications, Washington DC; Institute for International Economics
Hill, Hal and Takashi Shiraisi (2007), “Indonesia after the Asian Crisis”,
Asian Economic Policy Review, Volume 2 Issue 1, June, 123-141
Hussain, Qaizar and Clas Wihlborg (1999), “Corporate Insolvency Procedures
And Bank Behavior: A Study of Selected Asian Countries”,
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Ito, Takatoshi (2007), “Asian Currency Crisis and the International Monetary Fund”
Asian Economic Policy Review, Volume 2 Issue 1, June, 16-49
 11

Radelet, Steven and Jeffrey Sachs (1998), “The East-Asian Financial Crisis: Diagnosis,
Remedies, Prospects, Brookings Papers on Economic Activity,
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Rajan, Raghuram G. (2006), Perspective of Global Imbalances, Remarks at the Global
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The Strait Times, June 14.