August 8, 2002

Indonesia saw a lively debate regarding its future relationship with the IMF. It has been instigated by Planning Minister Kwik Kian Gie and it has ended with the cabinet decision to extend the current arrangement with the IMF till end 2003.

Throughout the month of June Indonesia saw a quite lively debate regarding its future relationship with the IMF. It has been instigated by Planning Minister Kwik Kian Gie and it has ended with the cabinet decision to extend the current arrangement with the IMF for another 12 months till end 2003.

There is good reason to presume that breaking away from the Washington institution has never really been considered by the impressive bunch of hardliners, which has joined into Kwik’s rethoric (Vice President Hamzah Haz and People’s Assembly chairman Amien Rais). Most probably, Kwik’s harsh words were targeted at a domestic audience, which needed to be confirmed that the government of Indonesia was not a puppy of Western interests.

However, the ambiguous character of the manoeuvre does not invalidate its content, particularly as former co-ordinating minister and actual BAPPENAS chief Kwik knows what he is talking about. So the questions he raised, which are definitely worth answering are:

· Is the cooperation with the Fund actually benefiting or rather harming Indonesia?
· Can there be a future for such a fragile economy as Indonesia’s without the inflow of new funds, which can only be mobilised by the Fund, and nobody but the Fund?

1. Cost-benefit-analysis At the outbreak of the Asian Crisis Indonesia found itself before the alternative to either let its largely bankrupt banking system go down the drain, or to use public funds to save it. Counselled by the IMF, the predecessor administrations of President Megawati decided to pile up a huge internal debt of the state, which today amounts to roughly half of GNP in order to recapitalize the actual banking system. The alternative would have been to disrupt a large part of Indonesia’s economic activity by accepting the bankruptcies of practically all the major Banks. Subsequently the same state funds would then have been used to finance a brand new credit industry under the control of the state. Administrations had some reason to fear the consequences of such a disruption and to rather do their utmost to keep the existing system working. The Indonesian state has had to pay a twofold price for this: First it has left most of the Suharto-era structures in the financial web of the country intact. Had the state dared to use the some 60 bn US-$ internal bonds to capitalize new institutions which might have taken up the banking function, this would certainly have caused major disruptions in the country’s economy. On the other hand it would have given the country a kind of fresh start regarding its financial and entrepreneurial elite – something which is painfully lacking, when nowadays even cabinet ministers lament that the country’s bureaucracy is “corrupt to the bones”.  Secondly, the recapitalisation of existing banks has manoeuvered Indonesia into a kind of debt trap. One of the merits of the debate instigated by Kwik was to have highlighted some of the most malign dimensions of this trap: As the recapitalisation bonds bear interest in the range of 13-14%, they place a heavy burden on the state budget. At the same time it has been an IMF key condition, to privatise the banks and to use the proceeds from these asset sales for closing existing gaps in the current budgets. This pressure to sell has lowered the assets’ value to the extent that in some cases the government can realistically expect to receive less for their assets than what they still owe to the sold institutions in the form of interest on the recap bonds. Observers consider a recovery rate of some 30% of what the state has actually invested as realistic. This, of course, is not only due to high interest rates but also to the poor quality of the recapitalized banks’ assets. A perfect trap so: No (meagre) sales – no balanced budget – no new money from the IMF (and other donors) – more budget problems. While many – including the author – had felt that in 98/99 reacpitalising the banks had been an unpleasant but unavoidable exercise, it now becomes clear that the government has put its head into the noose, which now starts being torn tight. It has been Kwik’s merit, and those’s, who, for whatever reason, have joined him, to at least have cried foul.

2. Could Indonesia do without the Fund? Kwik has not been the first influential politician of a Southern country ever to suggest, his country might actually do better without the IMF. From Alan Garcia to Kenneth Kaunda and more recently Olusegun Obansanjo, Southern heads of state and government have for honest or somewhat less honest reasons pointed their fingers to the “Colonialists” from Washington, and suggested their respective countries would do better on their own. They all have made the same fatal mistake, which only very few of their colleagues (Muhamed Mahathir of Malaysia being one of them) have managed to avoid: They have stood up, made a strong statement and then they have waited for the sky to fall upon their heads. They failed to do the decisive step, as they never answered the key question, where the money they needed was actually to come from, once the Fund personnel had cleared their offices in the Finance Ministries. The Fund (and those who back him) invest actually a lot of efforts into making governments believe that there is no economic future without the seal of approval by the Fund. Paradoxically enough the opposite is true, the more indebted a country is. Where could the Funds come from? From the debt service which a country saves, once it stops servicing them. Indonesia in fact, like most severely indebted countries, is producing a primary surplus; i.e. leaving interest payments aside, the central government is receiving more money than it actually pays out. In the 2002 budget the surplus amounts to the equivalent of some 5.3 bn US-$. Internal interest payments of some 59.6 tr. Rupiah (6.5 bn US-$) and external interest payments of some 3 bn US-$, turn the surplus into a deficit of 4.2 bn US-$. It is the interest on the foreign and domestic debt which actually forces the administration to seek new loans from inside or (mostly) outside the country. This goes not only for Indonesia. Even for such a prominent insolvency case as Argentina, this has been true until very recently. So, first of all: If the government wants to bring the public finances back into balance, receiving new loan to pay off old ones is only a viable solution, if you assume that the country is going to have disproportional growth rates. These have been projected by the World Bank in a full series of diagnoses, but never have materialized since the outbreak of the crisis. So, it is adequate for a government to pay tribute to the IMF’s poor track record as an economic consultant and to seek alternative ways of organising its economy. However, if the government of Indonesia really took this initiative, it needed to do a few things at the same time: · It needed to come up with a viable proposal of how to deal with its external and its internal debt. It needs to propose a regulation tailored according to the country’s needs and debt servicing capacities. This would necessarily pose the bunch of the burden on external creditors, including the International Financial Institutions; however, it needs to steer the distribution of internal hardships as well. Internal creditors, including the Banks which currently are enjoying a quite steady and risk-free stream of income, would have to have their haircuts as well.
· It needs to work for a fair and transparent framework through which it could implement a solution, which has a real chance to meet with general, albeit sometimes grumbling consent of the creditors. The most important element of this is an impartial institution, which would actually arbitrate between Indonesia and its creditors on the basis of an equally impartial assessment of the country’s economic situation. One of the most important results of such an impartial procedure would be the key incentive for private (and some official) creditors, to join into such a far-reaching solution: the perspective of finding in Indonesia a new financially viable partner and thus an investment sphere. Contrary to the favourite argument by creditors, that debt cancellation actually will cut the debtor off from financial markets, such a clear cut has for private as well as for public debtors regularly restored the debtor’s access to capital markets.

Does Indonesia have a chance to go any alternative way?
The answer is a double yes, for two quite different reasons. The first is: there is in fact no alternative to a new approach, unless the country is prepared to engage itself in an endless series of reschedulings with its external creditors, and to suffer internal financial turmoil, when it will have to default selectively on some of its internal commitments (and has to decide, which ones), or through trying to work itself out of its Rupiah-denominated debt by starting an inflationary spiral. In 2004 the internal debt service will increase to some 80tr Rupiah (some 7 bn US-$) and then remain in that range for about a decade. With annual external debt service also rising to over 5bn US-$ from 2005 on, there is no way for the Indonesian economy to produce enough revenue in order to afford that huge tribute to internal and external capital owners. Nobody in the Indonesian administration actually has a clue about where this money might actually come from. If the government waists the precious time it has won through the latest Paris and London Club reschedulings between futile attempts to accomplish the extraordinary growth rates demanded by the International Financial Institutions and occasional tough rhetoric, it will find itself quite empty-handed, when the moment of truth comes in January 2004. The second reason is that creditors themselves have started to consider new frameworks, particularly an international insolvency procedure, first of all in order to overcome their internal coherence problems. The proposal for a new Sovereign Debt Restructuring Mechanism (SDRM), started last November by the IMF Deputy Director Anne Krueger bears a huge potential for Indonesia. It can pave the way for some neutral institution to judge over Indonesia’s debt problem – instead of allowing the creditors to further claim this role for themselves. It can bind all creditors into a solution which is based on a realistic assessment of the country’s debt sustainability, and it can halt resource outflows, in order to allow for an orderly debt workout. Again, however, the crucial role will be with the Indonesian government. Only when Jakarta stops accommodating itself at the receiving end of decisions being taken elsewhere, can the reform debate in the Fund and in the broader international community (which has not been set in motion to please Indonesia), become fruitful for the country. That is why the debate started by Minister Kwik must not be allowed to die down.