Marcus W. Brauchli
Wall Street Journal
July 14, 1998
For a generation, the World Bank considered this sprawling archipelago’s rise from poverty its great triumph. Now Indonesia’s unraveling is raising questions about the World Bank’s long forbearance of the regime of former President Suharto.
A shattering economic reversal, sped by Asia’s downturn and the political crisis that ended President Suharto’s 32 years in power, is returning as many as half of Indonesia’s 200 million people to destitution. In some villages, they are unable to afford food and could face malnutrition. Banks are on the ropes, and the national airline is canceling aircraft orders.
It is a historic setback, in the words of the World Bank’s top official here. And no less for the bank than for Indonesia. Not only did the development agency lend money and credibility to Gen. Suharto, but critics say it tolerated and in some ways may have inadvertently stoked the corruption and economically corrosive practices that increasingly characterized the Suharto regime in recent years.
Accounts of current and former Indonesian officials and World Bank employees show that:
The bank, at the government’s insistence, softened reports on Indonesia’s economy, reports that helped the government win better rating and draw in capital. When the economy got dicey last year, this capital fled, undermining Indonesia’s currency.
The World Bank lent $307 millions to replenish the capital of state-run banks, which then channeled much of that money to companies run by Mr. Suharto’s cronies. It was the failure of those same companies to repay earlier loans that had necessitated the state-bank recapitalization.
World Bank officials knew corruption in bank-funded projects was common, but never commissioned any broad reports tracking how much money was lost to it – in part, some bank officials say, because they feared having to confront the government.
The bank went along with government estimates that showed epic improvements in living standards, despite indications the numbers were inflated. A majority of Indonesians long were clustered only a shade above the international $1-a-day poverty standard. Now a majority are well below it.
Morally, we now see the World Bank has done the wrong thing, as have many Indonesians, contends Mubyarto, an adviser and former vice minister of the National Development Planning Board. Like many Indonesians, he uses only one name.
Officials of the World Bank – which supports poor countries by lending for development projects – concede they should have pushed harder to show up weaknesses in a country that was a top client. The bank lent Indonesia more than $25 billion over three decades. We were caught up in the enthusiasm of Indonesia, the Washington-based bank’s president, James Wofensohn, told critics in Jakarta earlier this year. But, he added, I am not alone in thinking that 12 months ago, Indonesia was on a very good path.
Now, the bank’s soul-searching has begun. in every country that we operate in there is a trade-off between, shall we say, being pure and helping people, says Dennis de Tray, a University of Chicago-trained economist who has run the nearly 150-person World Bank missions in Jakarta for four years. We deal in the real world. We have to decide every morning when we wake up, are we doing more good than harm?
The balance, for a long time seemed positive. Indeed, there is no question that the World Bank’s development efforts, particularly in early years, helped wrench Indonesia toward modernity. From 1975 to 1990 its installed electrical capacity soared 18-fold, the number of telephone lines rose sevenfold and miles of paved roads grew sixfold, according to Adam Schwarz, author of Indonesia: a Nation in Waiting. Health care and literacy continued to lag, but, thanks to aid from the World Bank and other groups, they were improving.
Now, the bank estimates that Indonesian economy may shrink as much as 15% this year. Some private economists say it could shrivel to its size in the 1970s in dollar terms.
Mr. de Tray says it isn’t clear what the bank could have done differently, short of the nuclear-bomb option of cutting off all support. The bank, owned in part by its clients, is traditionally reluctant to cut a country off. Moreover, bank officials say, Indonesia’s economic and political weight makes it hard to muscle. We can kick Kenya around, or Costa Rica, says on senior bank official in Jakarta. You can’t kick Indonesia around.
Asked if he could recall the bank’s ever blocking projects because of corruption by Suharto interest, Mr. de Tray says on two occasions he was able to protest against corruption in World Bank-backed projects and get them righted.
The fact was, in the 1990s, few major projects escaped Mr. Suharto’s family or friends. When the World Bank objected in 1992 that only one bid, from a Suharto relative, had come in to develop a power project, the government reopened bidding. Another bid came in, from another Suharto relative, and contracts for two power plants were drawn up.
Inside the bank, though, economists argued that corruption could be viewed as a kind of tax on an otherwise sound economy. I think they really believed it, says Scott Guggenheim, a project manager a the bank’s Jakarta office. After all, The economists’ argument is almost unbeatable; how do you argue with 8% growth?
It wasn’t until 1997 that the World Bank, in public documents, used the C-word – corruption – according to Mari Pangestu, an economist at the Center for Strategic and International Studies in Jakarta and a past consultant to the bank. She says her earlier work for the bank was sanitized before publication, particularly to remove critical references to the government or its officials. I’ve written reports where, when I’ve gotten it back, I hardly recognized it, she says.
Consider the handling of the World Bank’s annual reports on the state of Indonesia’s economy. Such country reports are a source for economists, credit-rating agencies and investors. Reports on Indonesia highlighted its achievements but dance a semantic jig around such problems as nepotism and collusion. The bank did criticize their economic manifestations – monopolies and tariff protections set up to help Mr. Suharto’s children and friends – but names were never mentioned and working was almost a parody of bureaucratese.
In 1993, the bank noted the emergence of conglomerates that seek to capture rents created by policy-created market distortions. Translation: Suharto-crony businesses were given government-issues license to control, say, toll roads, ad Mr. Suharto’s daughter did.
Eventually, last year, the bank got tough, noting that certain government practices favor the well-connected over the efficient. They inflate costs. They engender cynicism and perceptions of unfairness. And they make it difficult to do legitimate business. Even then, though, it backed away, saying, Indonesia will need to address this issue sooner or later.
The soft approach was demanded by government officials, who, under World Bank practice, got to alter reports before publication. We called that consultation, says Frans Seda, a former finance minister. The government’s goal, he says, was to make conditions seem feasible for donor countries to lend.
Soedradjad Djiwandono, governor of Indonesia’s central bank until March, says the World Bank always went along with government pressure to tone down wording – something he says he now regrets. People say this is the Javanese way. He says. I’m Javanese, and I don’t agree with this You kept trying to reduce negative elements and because of that, perhaps we didn’t see things with a hard look.
The World Bank’s Mr. de Tray rejects suggestions the bank pulled its punches. There never was any argument about the message, but how do you deliver the message best in Indonesia. he says. And sometimes calling a spade a spade is not the best way.
But the softened reports fed perceptions that Indonesia’s problems weren’t undermining the nation’s economy. Steve Hess, a Moody’s Investors Service analyst, says his rating depended in part on the World Bank’s assessment. It’s useful to know what they think, he says, though he adds that he became increasingly skeptical of the reports.
By the 1990’s, capital was flooding into emerging markets, and billions washed up in Indonesia. Foreign investment approvals peaked at $18 billions in 1996, thanks in part to the World Bank’s imprimatur.
The wave of private money gave the Suharto regime false confidence, making the task of advising it even harder. The $5 billion or so the World Bank guided into the country each year didn’t matter so much in the context of tens of billions in private-sector investment.
To the government, the World Bank reports became a smokescreen. The government used the reports as weapons against criticism, says Loekman Soetrisno, a dean at Gadjah Mada University in Yogyakarta.
Says former Finance Minister Seda: Until October 1997, when the crisis was under way, the World Bank was telling the world the fundamentals were sound. Were they? No.
Recapitalizing the Banks
When conditions worsened in Indonesia, the private money fled, torpedoing the rupiah. The Indonesian currency has lost about three-quarters of its value against the dollar since a year ago.
As elsewhere in East Asia, Indonesia’s woes were compounded by a weak banking system, a problem the World Bank itself had been trying for years to repair. The fundamental problem was corruption: Until the 1980’s, Indonesia’s financial system was dominated by seven state banks that often channeled money to projects involving Suharto kin or friends. Those loans seldom were repaid.
In 1992, the World Bank offered $307 million in fresh bank capital in exchange for a promise of stricter banking safeguards. The central bank happily agreed to the rules, but enforced them poorly. Countries like ours are not known for strict bank supervision, says Mr. Soedradjad, who headed it.
A year later, when a central-bank list of bad debtors at the seven state banks was leaked, it showed that eight of the top 22 borrowers at the banks were behind on 40% of their loan repayments. On the list were several Suharto children and associates.
The World Bank, in effect, was subsidizing corruption, but all the while telling the government to cut it off. Contends Jonathan Pincus, a former United Nations aid official in Jakarta who now lectures at a London university. It was quite hypocritical.
The World Bank’s Mr. de Tray replies that the recapitalization project was intended to buy much, much higher levels of supervision because the state banks were the most politically influenced banks in the system. Did we succeed? No. Did we try? Yes.
The failure had broad reverberations. Rules meant to prevent Indonesian banks from loading up on foreign-currency borrowing were circumvented. The banks matched up their clients with foreign lenders, allowing them to gorge on dollar borrowing that carried lower interest rates than rupiah loans. The safeguards were circumvented, and foreign funds were flowing in like crazy, says Mr. Soedradjad, the former central banker. I kept building a sand castle, but there was a tsunami.
By the time the rupiah started to collapse a year ago, private-sector foreign-exchange borrowings has surged to $80 billions. As a result, most companies on the Indonesian stock market are technically insolvent now, because their debt in foreign currencies has been so magnified by the rupiah’s plunge. With $80 billion in debt, you can build up buildings in Jakarta, but you cannot pay it back, says Mr. Seda, the former finance minister.
The World Bank might have been expected to have more influence over its own development projects. Corruption was rampant in many of them, too. Not long after the bank’s Mr. de Tray arrived in Jakarta four years ago, he and Mr. Guggenheim toured a dozen villages in Java, looking at schools built with World Bank funding. All were crumbling. Mr. Guggenheim says, only months after their completion, the evident result of massive corruption that resulted in use of substandard materials. When bank officials brought it up with the Ministry of Education, they say, they were asked how they could judge the program after visiting only a dozen schools out of hundreds.
Like other public-sector money, World Bank capital was an easy target for corruption. An international aid worker who advises a World Bank-backed agricultural pest- management program says the bank’s insistence on channeling aid through the government worsens corruption by putting more hands near the money.
Kastorius Sinaga is an economist and former consultant to a $272 million World Bank-funded project to make grants to the Indonesia’s rural poor. When local officials would report to the central-government-controled economic office to get reimbursed for projects such as a well or a road, they would deduct a percentage, Mr. Sinaga says. If the project needed an installment of 150 million rupiah, the [government] official would take at least 15 million of this. But the demands could be even more.
The World Bank’s Mr. de Tray freely admits corruption is a deep problem in Indonesia, but says, We’re not judge and jury. We’re a development organization.
Banks officials try to steer projects away from danger areas. Mr. Sinaga’s program has broken down the grants into amounts smaller than $100,000 each because anything more starts to attract attention from companies close to Mr. Suharto’s family, according to Mr. Guggenheim, the project manager.
You can’t change the endemic system of the way Indonesia does business. Says Mr. de Tray.
Why hasn’t the World Bank more formally studied corruption in its Indonesian project They don’t want to know, contends Mr. Guggenheim, because such a report would surely leak and probably require the bank to make a relationship-rupturing case to the government.
In the bank’s long effort to fight Indonesian poverty – launched at Mr. Suharto’s invitation – all appeared to go well for a while. The bank trumpeted a steep drop in the Indonesian poor to 22.6 million in 1996 from 70 million in 1970. The only catch, say bank officials and other aid experts, was that the bank had to accept an Indonesian definition of poverty. It was a monetary sum, a rupiah base sufficient to enable the poor to get the internationally accepted norm of 2,100 calories a day.
The measure was controversial. Critics say the cash amount has been less than the globally accepted poverty line of $1 a day. Until the crisis, it was only about half that in Indonesia’s cities, and less in the countryside.
But the Indonesia government was able to strut about poverty-eradication successes, and move on to grander projects such as building infrastructure. The World Bank suggested in recent years that Indonesia soon would rise from a developing nation to a middle-income country because its average income level – a simple division of the country’s economic output by its number of people – had crossed the $1000 mark.
But that wasn’t the whole picture. Four of five Indonesians still lived below or only slights above the level of $1 a day. Mubyarto, the former vice minister of planning, who now advises the ministry on poverty programs, flatly says the reported dramatic lowering of poverty rates was false, and he accuses the World Banks of going along with it.
The Challenge Now
Jeffrey Winters, a Northwestern University professor who was a US Agency for International Development consultant in Jakarta in 1989, recalls an incident he says shows that Indonesia poverty numbers were pulled completely out of thin air. He recalls President Suharto insisting in public that poverty had dropped to 30 million, even though the World Bank, was in the middle of a three-year study that showed 60 million poor. He says AID officials tried to forge a compromise between the World Bank and the Indonesian government. In the end, the bank report put the number at 30 million.
It was a huge collusive effort, says Mr. Winters. The number has been reported over and over, but it’s a lie.
Bank officials say they stand by their numbers and by the clear evidence of poverty reduction in Indonesia. Our concern is not about the absolute level of poverty: That’s kind of an academic debate in some sense. Mr. de Tray says. It is whether or not consistent standards have been applied over a historic period.
For Indonesia, the challenge now is to get back to the first stage of development – growth. Doing that, observers agree, will require eliminating the corruption and distortion of the Suharto era.
Mr. de Tray says he is still trying to sort it all out. The bank recently began injecting new funds into Indonesia, particularly for social-welfare programs. I will admit to having a very strong sense of not understanding fully why things are so bad, the World Bank official says. Believe me, I’ve spent night after night thinking, what could we have done to avoid having so many millions suffer. I will probably think about it for the rest of my life.
Categories: Odious Debts