William Keeling
Financial Times
September 22, 1999

Half of an innocuous island nestling in the midst of the Indonesian archipelago is fast unfolding as Asia’s version of Kosovo. While East Timor is clearly a crisis for Indonesia, it is also a scathing indictment of western governments, which provided financial and military support for more than 30 years to the despotic regime in Jakarta.

While most people watch in horror news footage of the atrocities, many foreign bankers have already brushed aside East Timor as a minor irritant unlikely to affect Indonesia’s long-term economic prospects. They seem to forget that the implosion of Indonesia’s economy two years ago, considered by the World Bank as the worst suffered by any country since the second world war, had a root cause. Like abhorrent sibling twins, the civil strife in East Timor and economic catastrophe in Indonesia have a common parentage: the absence of the rule of law.

The former government of General Suharto and that of the present incumbent, President Habibie, poisoned the ground for long-term prosperity. A characteristic of despotic regimes is the absence of the rule of law in financial affairs. Despots cannot abide independent legal systems, preferring methods of threat and extortion to control business activity.

For western banks, this should spell disaster. Without the rule of law, they cannot lay claim to collateral pledged against loans that have turned sour. It becomes impossible, therefore, to price risk. Commercial banks, however, have slightly more sense than western governments. When commercial opportunities appear too risky even for the banks, governments often step in with export credit guarantees. Designed to help companies gain market share in lawless states, the inevitable result is the transfer of financial loss from the private sector to the taxpayer.

The UK’s Export Credit Guarantee Department, for example, has about 700m of defence-related exposure to Indonesia and has already paid out about 130m of public funds following Jakarta’s failure to honour contracts for British Aerospace Hawk jets. These aircraft, against express commitments, have been active in East Timor and may yet threaten the UN force. It is also ironic that Australia is leading the UN force mandated to intervene in East Timor. It was John Howard’s government that, in early 1998, lobbied the World Bank to release funds to the Suharto regime regardless of the latter’s domestic economic policy and human rights abuses. Coming from a nation that espouses democratic values, this last-ditch effort to shore up the Suharto regime was breathtakingly hypocritical.

The UK’s armament contracts and Australia’s support for Suharto served to reinforce the lawlessness of Indonesia’s financial and civil affairs. Both have allowed blood to be shed and money to be lost at the same time, for the same reasons. The fallout from embracing regimes that deny the rule of law is best understood by those who suffer physically and financially. The worst affected at present are the East Timorese. Next in line are the 100m Indonesians pushed below the poverty line as a result of the Suharto government’s corruption and economic mismanagement. An often disregarded third stratum are the ordinary citizens of western countries who underwrite in their taxes the misplaced policies of their governments and commercial banks. The suffering is of differing degrees, but the anger of the citizens of each country has a common root.

This is not ground-breaking analysis, yet those with civil and financial authority have failed to recognise it. In the months following Indonesia’s economic collapse, the International Monetary Fund provided more than $40bn in economic assistance. However, the IMF gave scant thought to the conditions that should be attached to the funds. In particular, it ignored the role that the rule of law plays in securing a nation’s financial health.

Eighteen months into its programme of aid disbursement, there has been widespread abuse of funds to bail out domestic banks. Monies have been diverted to the accounts of senior officials. The IMF, the Asian Development Bank and the World Bank have belatedly suspended loans. Playing the aggrieved financier, however, does little to establish the rule of law. What Indonesia needs is an independent judiciary, the creation of which should be a condition of future lending.

The consequences of the failure of western governments, donors and banks to press for the rule of law may be irreversible for Indonesia. With East Timor as a backdrop, rebel groups in the provinces of Aceh and Irian Jaya are likely to oppose Jakarta with renewed vigor. Other provinces, although not seeking self-determination, are divided between indigenous communities and so-called “transmigrants” from over-populated parts of the archipelago. Cultural differences between these groups have already triggered ethnic cleansing.

The danger of Indonesia breaking asunder is a real one. But 30 years of financial abuse by the Suharto government have left the provinces demanding accountability.

The west, with the financial muscle to make things happen, has responded with empty gestures. As if in mockery, the World Bank has adopted accountability and transparency as its catchwords. Yet without the rule of law, there is no accountability. Until this is taken on board, deepening instability in Indonesia and south-east Asia will be the only outcome.