The Meltdown of the Indonesian Economy: Causes, Responses and Lessons

Abstract

I. Causes of the Economic Crisis Since late 1997, Indonesia has been suffering from two interrelated crises: a political crisis and an economic crisis. The politically weak and technically incompetent governments of President Soeharto and President B.J. Habibie could not take bold, but sometimes unpopular, economic measures that were required for short-run stabilization and long-run growth. The present economic crisis consists of a banking crisis and an external debt crisis. Both external and internal factors caused the economic crisis. The external factors include: (a) regional recession, currency misalignment, and contagion effects; (b) the abnormal weather phenomena that has seriously affected food output and agriculture incomes in the rural sector, and (c) negative shock to the terms of trade. (Until recently, the price of oil was $10 per barrel, the lowest price in the past twelve years.) The internal factors include a fragile financial sector, excessive monetary growth, rapid accumulation of external debt by the private sector, and reduced quality of investment. Slow response and policy mistakes in the reform process magnified the already difficult problems. The strong economic fundamentals (low inflation rate, high economic growth and respectable growth of non-oil exports) that the authorities were so fond of boasting about before the crises were actually artificial. The low inflation rate was brought about by large subsidies to state-vended products. The high rate of economic growth (over 6 per cent per annum) was mainly generated in non-traded sectors of the economy (such as land-based industry, physical infrastructure, and the financial system). Most of the growth of non-oil exports during the 1990s came from sectors that relied least on domestic inputs and were associated with foreign firms. In contrast, exports from sectors that were domestically owned and which relied on domestic inputs, fared poorly. II. Structure of External Debt The external debt problem in Indonesia is centred on private sector debt, not public debt (see Table 1). In the period prior to the crisis, the authorities had kept the formal in surplus between 0.5 to 1 per cent of GDP. The consolidated of the public sector, however, may actually have been in deficit because of the large budget (popularly known as non-budget) expenditures of the public sector. The extra items include financial transactions of state-owned enterprises, and contingency liabilities of government-sponsored projects owned by the politically-connected private sector or by the powerful State Minister (later President) B.J. Habibie. TABLE 1 Indonesia: External Debt Outstanding, 1989-99 1989 1990 External Debt Outstanding (US$ millions) 51,974.7 62,320.6 Public Sector 39,576.9 45,100.2 Private Sector 12,397.8 17,720.4 The Structure of Private Sector External Debt (%) By Debtors 1. Banks 6.4 14.8 - State-owned Banks 3.4 6.4 - Private Banks 3.0 8.4 2. Non-bank 93.6 85.2 - State-owned Enterprise 26.0 17.6 - Foreign Investment Enterprise 26.4 26.4 - Domestic Investment Enterprise 23.0 23.0 - Financing Institution 3.9 3.9 - Others 14.4 14.4 By Maturity - Short term 6.9 6.9 - Long term 93.1 93.1 Memo items: 1. Share of Government Debt to Total Debt (%) 76.1 71.8 2. Share of Private Debt to Total Debt (%) 23. …