New York Times, January 14, 1998
I.M.F. Reports: Plan Backfired, Worsening Indonesia Woes
By DAVID E. SANGER
JAKARTA, Indonesia -- A confidential report by the International Monetary Fund on Indonesia's economic crisis acknowledges that an important element of the IMF's rescue strategy backfired, causing a bank panic that helped set off financial market declines in much of Asia.
In minute detail, the report describes how political paralysis in Indonesia was compounded by a misjudgment at the IMF's Washington headquarters on how the Indonesian people would react to bank closings. Instead of inspiring confidence as hoped, the closings helped bring Indonesia's banking system to the brink of collapse, sending depositors fleeing even from relatively healthy banks and hastening a further plunge in the country's already battered currency.
The report, distributed to IMF members last week, does not imply that the IMF bears any responsibility for worsening Indonesia's crisis. It attributes most of the blame to President Suharto's government, which it strongly criticizes for failing to enact promised reforms in exchange for the $40 billion international rescue effort.
Suharto's resistance to the economic changes demanded by the IMF resulted in warnings from the Clinton administration and from the lending agency last week that aid might be cut off. This, in turn, helped cause the nation's currency, the rupiah, to plunge and raised fears of political and social ferment in Indonesia, the world's fourth-most-populous country.
That is one reason President Clinton dispatched a team of top officials to meet with Suharto earlier Tuesday, in hopes of stabilizing Indonesia's finances before the country's troubles spread further.
IMF officials declined Tuesday to comment on the report, which came as the agency's Asian remedies are put under increased attack, particularly from political leaders throughout the region.
Newspapers and television programs are filled with accusations that the remedies prescribed by the IMF -- tight budgets, bank closings, high interest rates -- are worsening the pain just when businesses need loans and government funds to avoid mass unemployment and bankruptcies.
IMF and Clinton administration officials say publicly that the only way to truly clean up Asian economies is to dive into market reforms, however painful this may be in the short run. But the fund's report on Indonesia suggests just how hard it has been for governments and international organizations to turn that philosophy into specific policies and to apply them in the fast-moving Asia crisis.
The IMF's report -- formally the Indonesia Standby Agreement: Review Under the Emergency Financing Procedures -- describes how a turning point in the country's financial deterioration came in November, when officials here were forced by the IMF to close 16 insolvent banks, including at least one controlled by a son of Suharto.
The IMF's economists thought that bank closings would restore confidence in the rest of the country's banking system, by eliminating the bad apples.
Instead, the closings caused panic, the report acknowledges, in language that shows that the IMF hardly expected consequences opposite those it intended.
"These closures, however, far from improving public confidence in the banking system, have instead set off a renewed 'flight to safety,' " the report concluded."
Indonesians withdrew their money, taking $2 billion out of the banking system and shifting further funds out of private banks that they feared would be the next ordered closed. Some of that money was transferred to state-owned banks -- institutions that many people here believe guarantee greater safety.
By the end of November, the report says, two-thirds of all the country's banks "had experienced runs on their deposits."
The problem grew so critical, the report said, that the Indonesian central bank had to pump money into the private banks "equivalent to about 5 percent of GDP over the past two months." Indonesia's gross domestic product, a standard measure of economic output, exceeded $200 billion last year.
The harried effort to keep the banking system afloat undermined efforts to deal with the nation's other major problem, the plummeting value of its currency, the report says.
The main mechanism any government or central bank uses to defend a currency's value is to raise interest rates. But pumping more money into a banking system -- making the currency more plentiful --is a form of interest-rate reduction. So the central bank quickly found itself torn between twocontradictory goals, and careened back and forth between them.
"This situation has led to an uneven monetary policy, in which the central bank has shifted its focus from one objective to another, depending on the one which seemed most pressing," the report says.
The requirements imposed on Indonesia by the IMF, including the closing of insolvent banks, are similar to those demanded of Thailand and South Korea, the other Asian nations that have needed enormous international bailouts in recent months.
Neither of those nations appears to have experienced a bank run of the magnitude of the one that hit Indonesia. Still, their financial markets have remained volatile, their currencies remain vulnerable to further declines and few economists or politicians will venture a guess as to when the crisis might pass.
This is not the first time an IMF order to close banks resulted in a panic. When some banks were closed early in the Mexican crisis in 1995, depositors also reacted by hastily withdrawing their money from many banks.
Banking officials who went through the Mexican experience say there is always a risk that when regulators close one group of banks, the public will conclude they are making a broader statement about the health of the entire system. Less experienced regulators -- like Indonesia's -- can frequently compound this problem by failing to make their intentions clear, and from failing to separate troubled banks from healthier banks.
In this case, one of the closed banks, owned by a son of Suharto, reopened under a different name a few days later after the son challenged the Indonesian Finance Ministry's right to close his bank at all.
While the IMF's acknowledgment that the bank closures went awry is sure to provide new ammunition to critics of its austerity-driven approach, that miscalculation was only one element of a report that chiefly finds Suharto's government responsible for the worsening crisis by failing to take seriously the required reforms of the economy.
In language far more direct than officials have used in their meetings over the past two days with the 76-year-old leader, the IMF concluded that within days of the signing of the $40 billion accord "economic reforms seemed to disappear from the government's agenda."
Suharto reconfirmed his commitment to the IMF's prescriptions Tuesday in a meeting at his residence with U.S. Deputy Treasury Secretary Lawrence Summers. But they are clearly being revised, and changes are expected to be announced Thursday when the IMF director general Michel Camdessus comes to Indonesia.
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