During the Wahid era Indonesians started to get used to news about the dismissals of government officials, including cabinet ministers and generals, beginning with the dismissals of the then Minister for Trade and Industry Jusuf Kalla and the Minister of Public Enterprises Laksamana Sukardi in July 2000. To make things worse, a dismissal was usually preceded by rumours and media reports.

However, my dismissal as Governor of the Bank Indonesia by President Soeharto several weeks before the end of my term attracted unusually widespread public and media interest. At the same time, the reasons for this unprecedented sacking of a Central Bank governor have remained a mystery, hence my justification for writing this book.

Dismissed as Bank Indonesia Governor

I was dismissed from my post as Governor of Bank Indonesia through a presidential decree on 11 February 1998. Official release from the post took place at the installation of my successor, Dr Sjahril Sabirin, on 19 February 1998. The new governor and myself undertook the legal transfer of authority at Bank Indonesia on 23 February 1998, thus formally ending my tenure, which had begun upon the installation of Development Cabinet VI on 21 March 1993.

My dismissal was unusual because on previous occasions, at least since 1983, the replacement of the central bank governor had usually been in tandem with the change of cabinet ministers. Since 1983, the position had also been accorded a state minister of cabinet status. Indeed, in this system the post of Central Bank Governor was equivalent to the posts of the Attorney General and the Commander of the Armed Forces — all three had state ministerial status. On one or two occasions the handovers were one or two days later than those of the cabinet ministers, but never weeks apart. The new cabinet, Development Cabinet VII, was installed on 16 March 1998 but my dismissal and the legal transfer of authority were all several weeks prior to this.

What seemed to be the reason behind the President's haste? Some government officials immediately made the standard comment that the replacement of an official was the prerogative of the President and that it was “normal”.

Poor Implementation or Bad Programme?

The implementation of the IMF-supported programme started with the execution of the decision to close insolvent banks on 1 November 1997. In the jargon of IMF stand-by arrangements, this was a prior action, part of the conditionality. In fact it was a step that had to be taken by a recipient of a stand-by loan prior to the board deliberation to discuss the LOI sent by the member government to ask for a SBA.

The government announcement on the bank closures was made by The Minister of Finance, the Governor of Bank Indonesia and the Minister of Trade and Industry in the Ministry of State Secretariat, on 1 November 1997. Both the Minister of Finance and the Governor explained the background and the reasoning for the government's decision. Minister of Finance Mar'ie Muhammad explained in detail about the government policy of bank closures and the whole adjustment programme in the Parliament on 10 November 1997. In his explanation, he mentioned five criteria for a bank to be targeted for closure, which included: bank assets that could not cover liabilities; when a bank had insufficient income to meet its liabilities; caused by bad debts; a bank's inability to mobilize public funds, forcing it to rely on the inter-bank money market; negative net worth; and ignoring repeated warnings from the central bank.

The bank closures involved 16 banks with more than 400 offices all over Indonesia. A limited deposit guarantee was provided that was modelled on the liquidation of Bank Summa in 1992. At the liquidation of Bank Summa five years earlier, the government paid deposit owners a maximum of 10 million rupiah. This time, each deposit account was paid to the maximum of 20 million rupiah (approximately US$6,000). So, deposits equal to or less than 20 million rupiah would be paid the full amount, and those over it would be paid 20 million rupiah each. The number of deposit accounts equal to and less than 20 million rupiah of the closed banks numbered more than 660,000 accounts, which equalled to more than 94 per cent of the total number of deposit accounts of the closed banks.

Writing this book has taken far too long. Aside from my limited writing proficiency, this has also been due to a variety of reasons including deciding which issues to include, how detailed the discussions should be, the relevance of each issue, and the mentioning of names. In addition, there have been personal problems that have been distracting.

I have spent many days and hours testifying in public hearings in the Parliament and answering questions, the Police Headquarters in the process of interrogations by the Attorney General's Office, or testimonies in courts on cases of alleged corruptions in the provision and utilization of Bank Indonesia liquidity support. From end 1999 to the present all these testimonies and interrogations have cost me months of concentration and writing time. In May 2002, I was myself named as a suspect in a case alleging that, together with other members of Bank Indonesia's board of directors, I violated my authority by providing liquidity support to banks that caused trillion rupiahs worth of losses to the state.

The Indonesian crisis lingers on and recovery seems elusive.

Indonesia has been faring badly in comparison to the performance of other crisis countries that also resorted to the Fund's stand-by arrangements. Thailand, which asked for stand-by arrangement in August 1997, did not need to use the whole facility due to its faster recovery. Korea used up the whole facility. However, Korea has already made repayments on most of the facility (Supplement Reserve Facility) that the country received since December 1997. In the Fund evaluation of its support to the Asian crisis countries in 2000 the concern was for these countries becoming complacent because the Korean recovery happened so fast.

The development of the crisis and its resolution in Korea and Thailand has been in reverse to what happened in Indonesia. If the two other countries no longer need the Fund and the stand-by arrangements, Indonesia is badly in need of both the Fund as well as its support for gaining back market confidence.

By the end of 2000 or two years after the beginning of the IMF's involvement in Indonesia's efforts to address the crisis, Indonesia had experienced four cancellations of its withdrawals of the loan due to non-compliance or delay in the fulfillment of the conditionality.

First Review

Confronted with deteriorating economic, financial and banking conditions towards the end of 1997 and beginning of 1998, the government undertook a variety of adjustment steps. But since the programme was part of the agreement with the Fund in a stand-by arrangement, a review to evaluate the implementation of the programme, including compliance to performance criteria and other conditionality as stipulated in the first letter of intent, had to be conducted.

The evaluation of programme implementation would determine whether a drawing from the loan could be made. The evaluation was also needed to determine any other changes or additional steps that should be included in the adjustment programme.

The second LOI was negotiated directly by President Soeharto with the Fund team. The new programme of financial restructuring and economic reform was basically an enhanced and improved programme of the one contained in the first LOI. President Soeharto himself signed the second LOI on 15 January 1998. The President's direct involvement was an extraordinary step.

In the IMF's review of 7 January 1998 it was stated that “performance under the programme so far has been decidedly disappointing.” It was further stated that “although some progress has been made, there have also been policy slippages in every area of the programme.” In particular, it was noted that the interest rates finally being raised would not be sustainable due to pressures from government officials who demanded the lowering of rates. The promise to produce a budget surplus also seemed to be remote. Most troubling, in the Fund's evaluation, was that the authorities had taken a number of structural steps backward, especially in governance.

The review noted further that as a result of the policy performance, hard-won market confidence, built up over three decades of rapid economic progress, and revived at the outset of the arrangement, had vanished. The development had prompted the collapse of the exchange rate.

Caveat

Since the beginning, I have been confronted with a dilemma in the writing of this book. One motive for writing this book has been the wish to share with the public my observations, assessments as well as analysis about a crisis that has had an impact on all aspects of life in Indonesia. The crisis has been an extraordinary period for the Indonesian economy. However, due to my former position as one of the key players in the government, that strong wish has been clouded with an uneasy feeling concerning possible criticism of self-defence or self-justification about whatever role I played in it.

My assessments may, of course, be affected by hindsight, or even normative values as part of my wish for something to have happened, instead of what actually did happen. I have been aware of these issues from the beginning of the endeavour. I even blame its long-delayed completion to this dilemma.

However, I write this book not as an apologia. To those who in fact perceive it this way, I would like to assure you that this is not the intention.

The crisis and its implications and the effort to resolve them are still unfolding. So, the story will continue, even though the players have changed. Much has been written about the crisis, and I am sure there will be more accounts. It is hoped that this book will complement them. Through this the public could ultimately receive a complete and accurate picture of what went on during this important period.

I have also been confronted with a classic problem of history writing, i.e. to determine when to start and when to end. The issues and problems continue, which complicates the determination of when to end the narration. For practical reasons, the focus of these discussions has been on the period of my term at the central bank. So in general the analysis starts with the beginning of the financial crisis in July 1997 and ends with my dismissal in February 1998.

The idea of writing an assessment and analysis of what had been developing in Indonesia's economics and finance had been with me for some time. It started around the middle of my five-year term as Governor of Bank Indonesia, when the Bank commissioned a team to write a history (Rahardjo 1995). The idea was to write about my experience as well as assessment of the management of the national economy, as viewed from the Indonesian central bank.

Due to the crisis that struck Indonesia in early July 1997, I decided to work on the Indonesian crisis first. With my dismissal, I wanted to write about what I had observed, analysed, and decided during the crisis in my capacity as one of the key Indonesian economic policymakers. I told President Soeharto about this plan during my last meeting with him at his residence.

I ultimately wrote a book, Mengelola Bank Indonesia dalam Masa Krisis (Managing Bank Indonesia during the Crisis) and Bergulat dengan Krisis dan Pemulihannya (Fighting the Crisis and Its Recovery). Both were written in Bahasa Indonesia, and were published in October 2001. The present book is a revised English version of the first book.

The Indonesian crisis as a part of the Asian crisis has been analysed and reported on extensively. It has also been widely discussed at many conferences and seminars. Many have argued that the Asian financial crisis was the worst since the Second World War. Meanwhile, the Indonesian crisis has been portrayed as the worst case in the Asian crisis as measured in terms of different economic and social indicators and the depth and spread of its negative impacts.

The Indonesian crisis originated from an external shock in the foreign exchange market that contagiously caused a drastic depreciation of the rupiah, then became a total crisis. The shock in the foreign exchange market that originated from the Thai baht crisis produced a chain of effects that exposed structural weaknesses in Indonesia's economy, and its socio-political fabric, which were hitherto hidden by high economic growth.

Home Grown but Not Home Alone

During the first year of the Asian crisis, discussions among experts and writings in the media and professional journals had not been clear in showing the origins or development of the crisis.

Only after more than a year of confusion did some kind of general consensus emerge on the causes of the crisis, policy responses by governments, as well as market reactions toward the crisis. The different views on these matters could be traced to the different perspectives on economics, which are more difficult to mediate.

The differences seem to arise from different schools of thought, which may be based on the conventional distinction between classical and Keynesian economics. Simply put, classical economists rest their arguments on the belief in market mechanisms and argue that any form of intervention in the market is to be avoided because it creates distortion. In contrast, Keynesian economists argue that the market is basically unstable and that government should intervene to create stability.

Analyses about the Asian crisis itself can be distinguished in two broad groups. The first group argues that the crisis was home grown and arose from practices of crony capitalism and weak financial structures plus inept macroeconomic policies (Krugman 1998). The second group saw the crisis as triggered by a shift of sentiment in the financial market that caused financial panic. The second view argues that the crisis was basically a financial panic in the Keynesian tradition, as succinctly explained by Charles P. Kindleberger in his seminal work two decades ago (Kindleberger 1978). Jeffrey Sachs has been the major proponent of this view (Radelet and Sachs 1998).

Stephan Haggard refers to the first group as the internationalists and the second, the fundamentalists. In addition, he also mentions the existence of the third group; these he refers to as the new fundamentalists, who specifically mention weak regulations and institutions in the financial sector as the cause of the crisis (Haggard 2000, p. 4).

With respect to the Indonesian crisis, similar questions could be asked.

Controversial Issues

Several steps that were taken by the government and the central bank during the crisis have become the subject of public debate in Indonesia and unfortunately have not been resolved to the present. Some policies have even become controversial, due partly to the lack of clarity on the part of many concerning what had been the real issues or the reasoning behind steps taken.

I will discuss three of them, namely the policy of granting liquidity support to banks; the debates on fixing the currency to the dollar in a currency board arrangement; and the issues associated with granting autonomy to the central bank.

My discussions here will not guarantee the disappearance of the controversies if the differences resulted from ideology or vested interests, in particular if “tribalism” is involved (Budiman 1999).

Liquidity Support to Banks

In tandem with the bank closures of November 1997, the most controversial policy launched during the crisis was the liquidity support to banks in distress that Bank Indonesia provided.

Was this a government or a central bank policy? What was the reasoning in either case? How should the losses arising from the liquidity support be apportioned between institutions? Who should be held responsible for the policy and its implications? How did the government deal with the alleged corruption?

The liquidity support to banks that Bank Indonesia provided during the crisis became controversial when the Supreme Audit Board issued two reports on the audits conducted in fulfillment of a request by the Parliament. The first one was a general audit report with a disclaimer, which the Agency issued in November 1999. The issuing of an audit report with a disclaimer is automatically read as a sign of problems in the audited institution, i.e. Bank Indonesia in this case. The second report was on an investigative audit on the central bank due to alleged possible criminal acts of corruption.

IMF — Supported Programmes

By formally receiving a stand-by loan from the IMF, the government's efforts to address the crisis entered a new phase. The programme was very comprehensive, and supported by the Fund. The government policy became a macroeconomic adjustment programme to deal with balance of payments disturbances, which reflected imbalances in the national economy.

The IMF functions like a credit union, whereby member countries borrow from it by using other member countries' funds. On the other hand, the IMF also simultaneously plays the role of lender of last resort, providing member countries with international liquidity in times of need.

The rest could only be drawn with conditions. This would be the part that has the characteristic of a loan, not a facility. The fund is taken from the general resource account (GRA) of IMF, and interest rates are not subsidized. This can only be drawn in stages, depending on the compliance of the borrowing country with respect to the conditionality. If the member country fails to fulfil part or the whole of the conditionality, the country will be denied from withdrawing the remaining amount of the loan. However, sometimes the stand-by loan is also called a facility. I will be using these terms interchangeably.

The phasing of the loan on top of the credit tranche can be in accordance with the needs of the receiving country. It could be initially large and subsequently smaller front-loading, or the reverse of it, with a large disbursement in the later period and less in the early part (back-loading).

Technically speaking, the actual IMF facilities are IMF loans not funded from the member countries' contributions. The funds are, for example, from the sale of IMF gold. These facilities usually bear subsidized interest rates. The single most important facility is the loan to assist highly indebted poor countries (HIPC) in the form of an enhanced structural adjustment facility (ESAF). In 1999 this facility was transformed into a new facility, called poverty reduction and growth facility (PRGF).

Some Facts

The Indonesian crisis has lingered on, becoming the worst in Asia. It may even be simply just the worst amongst crises countries that the world has experienced in the recent past. Even though this has been generally accepted as fact, it is still pertinent to ask why is this so. In particular the question is relevant if confronted with another well accepted claim that, at the outset, the relevant fundamentals of the Indonesian economy were either at par with or even better than other crisis countries in Asia, and that the initial policy responses by the government were considered prudent and timely.

Together with two other crisis countries in Asia, namely Thailand and the Republic of Korea, Indonesia asked the IMF to assist the government in designing and implementing policy adjustment programmes through the framework of stand-by arrangements.

It is instructive to compare some macroeconomic indicators on vulnerability to external shocks, as shown in Table 9. With respect to external trade performance, both export growth as well as current account deficits in the first five years of the 1990s, and 1996 for Indonesia were better than for Thailand and Korea. The growth of credits from commercial banks prior to the crisis was relatively better for Indonesia.