The IMF and the U.S. Treasury would pin most of the blame on Suharto when the rupiah cratered in late 1997 and early 1998. They would accuse the seventy-six-year-old Indonesian president of undercutting efforts to restore confidence in his country’s economy by breaking promises he had made to prevent his children and cronies from receiving favored treatment. Although Suharto deserved much of the culpability for what happened, misjudgments by the IMF and other elements in the High Command would play no small part. The story is disheartening on many levels. Disputes, philosophical differences, and bureaucratic battles within and between the staffs of the IMF, World Bank, and Asian Development Bank would hamper the efforts to diagnose Indonesia’s troubles and mount an effective rescue.
Recrimination and debate continues to rage over who was right. The Indonesian crisis is a tale of error piled atop error, with each side’s bad moves—both the Fund’s and the Indonesians’—compounding the other’s and dragging the country’s economy to depths nobody had previously imagined possible.
In many ways, Indonesia’s economic management prior to the crisis had been brilliant. Over the course of his thirty-year rule, Suharto had entrusted many important decisions to a group of technocrats, dubbed the “Berkeley Mafia” because several of them had received their economics training at the University of California. The leading technocrat was Widjojo Nitisastro, a soft-spoken professor to whom Suharto had turned in 1966 to devise an economic plan for lifting the country out of its deep impoverishment. They made an unlikely pair—Suharto, an army general who grew up on a farm in Java and was trained in military matters, and Widjojo, an intellectual who held a Ph.D. from Berkeley. But Suharto backed the efforts by Widjojo and his associates to shift Indonesia’s economic policies toward the orthodox theories taught at the most prestigious Western universities and think tanks. The Berkeley Mafia dismantled much of the statist economic structure built by Indonesia’s former President Sukarno, and imposed tough restraints on government spending and money creation to quell triple-digit inflation. Battling politicians and ministers who favored more nationalistic policies, they pressed Suharto to open the economy to foreign investment and trade and ease up on heavy government regulation. Their approach paved the way for a period of growth that averaged 7 percent a year from 1979 to 1996, with relatively stable prices. Millions of Jobs were created as firms set up factories to produce clothing, shoes, toys, furniture, and electronics.
Although powerful rivals and special interests often outmaneuvered Widjojo, who held no official title beyond “economic adviser” after 1983, Suharto invariably relied on him when the economy hit a rough patch, as it did in the mid-1980s when the price of oil, a key export, collapsed. Widjojo’s reputation for honesty was beyond reproach; he drove a modest car and worked in a seldom-redecorated office. Indeed, one reason IMF officials cited for their confidence in October 1997 was the announcement that Suharto was asking the seventy-year-old Widjojo for a return engagement to shepherd the government’s response to the rupiah crisis.
Among Indonesia’s most enthusiastic boosters—and surely its most influential—was the World Bank, which had lent about $25 billion to Jakarta during Suharto’s three decades of rule and treated the country as a poster child of economic development. As it stated in a 1994 report on Indonesia, “The evidence clearly suggests that the poor have been doing well, and far better than in most other developing countries.”
Journalists visiting Jakarta around that time could hear a compelling, up-by-the-bootstraps story about Indonesia from the World Bank’s resident representative, Dennis de Tray. An Ohio native in his early fifties, the aristocratic-looking de Tray had spent much of his youth in Mexico City and Nairobi—his father was a veterinarian who researched animal diseases such as African swine fever—and when he returned to the United States to attend Cornell University, he was determined to settle in small-town U.S.A. and never venture abroad again. But after getting his Ph.D. in economics from the University of Chicago and spending twelve years at a think tank, he Joined the World Bank’s research department in 1983 and moved to the operations side a few years later. In the Indonesia Job, which he got in 1994, his passion for the country’s successful development was manifest.
De Tray and his chief economist, James Hanson, touted figures charting the country’s progress that were downright inspiring. Indonesia’s per capita income in 1970 had been two-thirds that of India and Nigeria, but by 1996 it had risen to $1,080, four and a half times that of Nigeria and triple that of India. Life expectancy at birth in Indonesia was sixty-five by the mid-1990s, compared with fortynine a quarter century earlier; the adult illiteracy rate had fallen to 16 percent from 43 percent; infant mortality had shrunk to 49 per 1,000 live births from 114.
Visitors who wanted to see what all this meant for average Indonesians could trek to villages in the lush, hilly interior of Java, where residents would recount the ways their lives had improved. For example, whereas two or three decades before, most of their meals had consisted of corn or cassava (a starchy root with little nutritive value), now they were eating rice three times a day with vegetables, tofu, and often some egg or meat. Whereas they formerly lit their homes with kerosene lamps, now many homes had electricity, at least on Java, the country’s most populous island. Whereas a family used to count itself lucky in the 1960s and early 1970s to own a bicycle, now many of them had motorcycles. Whereas it had been difficult to bring products to market or get to school on the bumpy dirt road running through the village, now that road was paved.
The country’s most glaring problem was “KKN”—korupsi, kolusi, dan nepotisme (corruption, collusion, and nepotism)—and the World Bank had a long list of complaints about sweetheart deals in an array of sectors that were enriching people with presidential connections. De Tray, Hanson, and other World Bank staffers in Jakarta prided themselves in hectoring the government about these issues, writing about them in official reports, and encouraging the Western press to publish exposés.
By the 1990s, the Suharto family’s avarice was so pervasive that almost any foreign firm investing in, say, a power plant or phone system or petrochemical factory had to hand over lucrative partnership rights to one presidential relative or another to grease the proJect’s way through the country’s bureaucracy. Bambang Trihatmodjo, Suharto’s second-eldest son, headed the Bimantara Group, which was granted a television license, special concessions for overseas distribution of the state petroleum company’s products, and high tariffs to protect a $2.2 billion plastics plant built Jointly with German and Japanese multinationals. Suharto’s daughters also became multimillionaires thanks to government-granted contracts to build power plants and toll roads, among other ventures.
As for the president’s youngest son, Hutomo Mandala Putra, (nicknamed “Tommy”), he enjoyed the benefits of a monopoly on the distribution of cloves, which are used in the scented kretek cigarettes favored by most Southeast Asian smokers. And in early 1996, Tommy’s conglomerate was awarded perhaps the most outlandish concession of all—the rights to build a “national car,” called the Timor. Not only was the venture exempted from luxury taxes and allowed to undercut its rivals by importing cars and parts duty-free from its Korean partner, Kia Motors, but it also received $700 million in bank loans, reportedly thanks to Jawboning by powerful officials. The cars bombed with consumers, which led to government ministries and local corporations being subjected to pressure to buy fleets of them.
This is not to say that a blood relationship to the president was required for favored treatment. Some of the largest fortunes in Indonesia belonged to tycoons with whom Suharto had long engaged in mutual back-scratching. Most of these men were of Chinese origin; the ethnic Chinese, who accounted for about 4 percent of Indonesia’s population, owned a proportion of the country’s wealth variously estimated at 40 percent to 70 percent, a source of considerable tension in Indonesian society. The richest was Liem Sioe Liong, who as a supplier to the Indonesian military in the 1940s and 1950s hel
ped advance Suharto’s career. Among the more than 200 companies that Liem controlled were Indofood, the world’s biggest instant-noodle maker, and Bogasari Flour Mills, the world’s biggest flour-milling operation, which held de facto monopolies in the Indonesian market thanks to government contracts, special import licenses, and subsidies. Liem’s empire also profited from government concessions allowing him to carve out immense palm oil and timber plantations on the island of Sumatra.
Still, as repugnant as such dealings were in a country where tens of millions of people were barely surviving on a couple of dollars a day, many experts—including those at the World Bank—regarded the KKN problem as wasteful and lamentable but not fundamentally threatening to the economy’s well-being. In this view, Suharto was no kleptocrat on the order of, say, Mobutu Sese Seko of Zaire or Ferdinand Marcos of the Philippines, whose crony-dominated rule had bled their countries dry. Thus the World Bank, while repeatedly admonishing the regime to address “governance” issues, maintained an upbeat outlook. Its president, James Wolfensohn, set the tone by traveling to Jakarta in May 1996 and delivering a cheery speech after having rejected a more cautious draft written by his staff. “If you weigh up the odds,” Wolfensohn said, “I have a very strong sense that this country is addressing the right issues to ensure sustainable economic growth.”
But that assessment overlooked a source of rot in the Indonesian economy—related to KKN, but not exactly the same issue—that posed a grave danger to the country’s economic stability. The rot was in the banking system. Ironically, the keenest insights into the depths of this problem would come from within the World Bank itself.
Headquartered across 19th Street from the IMF, the World Bank is a considerably bigger organization, with a staff of 10,000. It lends about $20 billion a year to the governments of developing countries, and its loans have financed many heartwarmingly successful projects that help spur economic development and reduce poverty. A program it funded in southern India, for example, is credited with rescuing several million children from malnutrition simply by educating mothers there about how to nourish their offspring properly with readily available foods. World Bank loans helped spread high-yield farming techniques in India, Pakistan, and Indonesia—the “Green Revolution”—that turned those countries into dynamic agricultural producers. In Indonesia, the World Bank helped finance an expansion of the country’s electric power system that increased the capacity of the state power company fivefold between 1978 and 1992, and it also funded a number of other widely praised projects that provided school textbooks, teacher training, and family planning services. The family planning project helped cut the country’s fertility rate by 60 percent.
The World Bank has some serious weaknesses, however, chief among them its bureaucratic, inward nature, which has led it to fund projects without proper understanding of the gritty realities in the countries concerned. A notorious example was a road through the Brazilian rainforest it financed in the early 1980s, which attracted hordes of migrants who razed a vast area and spread deadly epidemics among the aboriginals. Another, related problem at the institution is a syndrome called the “approval culture,” or “lending culture.” For decades, staffers have gained stature and promotions by drawing up impressive-looking loan proposals at headquarters, pushing them through the elaborate approval process, shoveling the money out the door, and moving on to the next loan. Sometimes the resulting projects succeed in the real world; sometimes they don’t. Despite strenuous efforts by World Bank presidents (including Wolfensohn) to eradicate the syndrome, it has persisted, and all too often success in the loan development process has mattered more to staffers’ career advancement than the impact of the projects on client countries.
In August 1996, a team of about a half dozen World Bank experts on banking and financial issues traveled to Jakarta to evaluate a three-year-old project seemingly imbued with the classic characteristics of the approval culture. The mission was led by Lily Chu, who had recently come to the World Bank by way of Harvard, where she earned an M.B.A. and Ph.D. in finance.
The project the Chu mission came to assess, like all Bank endeavors, was based on good intentions. It was supposed to help improve management and operations at Indonesia’s seven giant state-owned banks, which accounted for nearly half the assets in the banking system and needed assistance—lots of it—in cleaning up their acts. They were a large, weak link in a banking sector that had grown explosively—the number of banks increased from 108 in 1988 to 232 in 1993—following a deregulation of the industry. The underlying soundness of the state-owned institutions was highly questionable because the Suharto regime had influenced their lending decisions over the years to funnel loans to favored businesses. So in 1993, the World Bank had begun a project, funded at about $300 million, to provide the state-owned banks with an incentive to bring their operations up to proper commercial banking standards. If the state-owned banks put their finances on a stronger footing by decreasing the amount of nonperforming loans on their books, they would get an extra dollop of capital investment from the government.
But as the Chu mission found, the project was producing the opposite impact from its intended one. Offering the state-owned banks the dollop of capital encouraged the banks’ managers to cook their books so that it looked as if their balance sheets were improving. Instead of causing the state-owned banks to strengthen their financial conditions, the project was causing matters to worsen.
More upsetting was what the World Bankers found as they dug deeper into the files of the state-owned banks. The team discovered case after case of the worst sort of banking practices imaginable. Bank officers were granting fresh loans to borrowers that had stopped paying interest on old loans. The documentation on many loans was grossly irregular, suggesting that the loans were being granted either out of complete incompetence or outright dishonesty. For example, borrowers’ accounting statements would show after-tax profits to be greater than pre-tax profits, or they would show profits exactly the same, to the rupiah, one year to the next. Loans were being granted in excess of projects’ costs, evidently to cover “facilitation fees” that were being kicked back to the loan officers and their superiors.
Altogether, bad loans at the participating state banks exceeded 25 percent, and worse, the team concluded that supervisors and examiners at Bank Indonesia, the country’s central bank, were turning a blind eye to these sorts of activities—presumably in exchange for bribes. Foreign and domestic bankers confided horror stories and market scuttlebutt about Bank Indonesia examiners taking underthe-table handouts.
Upon returning to Washington, the Chu team delivered a disturbing report about what it had found: The state banks were so riddled with bad loans, and the World Bank’s project so counterproductive, that the remainder of the project should be canceled. Their recommendation sparked fierce opposition from some of the World Bank’s old Indonesia hands, who argued that although the project might be badly flawed, canceling it would only damage the World Bank’s relationship with the Indonesian government and eliminate its sole means of exerting leverage over the country’s financial authorities on the banking sector’s problems. Accusations flew on both sides: As far as Chu’s critics were concerned, she was a typically bright but overly brash, inexperienced interloper with little understanding of how Indonesia worked. As far as Chu’s partisans were concerned, her critics had “gone native” and lacked a deep grasp of banking issues. Chu lost; the project was not canceled until the Indonesian crisis was well under way.
Amid the bureaucratic firefight, the World Bank missed a broader lesson from the Chu mission: Indonesia’s entire banking sector (not Just the state-owned banks) was in such serious trouble that an intensive World Bank effort was needed to help the government address the weaknesses and prepare for a potential crisis in the system. A report by an internal watchdog unit would later castigate the World Bank’s management for having “downplayed the evidence” in the Chu mission’s findings and for having neglected to
take aggressive action. This criticism, to be sure, not only was based on 20-20 hindsight but also failed to take account of the likelihood that the Indonesian government would have rejected whatever reform initiatives the World Bank proposed. Still, at least some blame for the lack of effort should have gone to what the watchdog unit called a “halo effect” that existed in relations between the World Bank and Indonesia because of the “enthusiasm associated with [the country’s] rapid growth.”
The “halo effect” was evident in the World Bank’s strong institutional disinclination to believe Indonesia was seriously imperiled. On July 10, 1997, a week after the devaluation of the Thai baht, World Bank staffers submitted a report to the board, dismissing worries that Indonesia would succumb to the sort of currency sell-off that had Just hit Thailand. “Indonesia is relatively well equipped to cope with any spillover effects of such a [regional] crisis because of the wide exchange-rate bands, increasing and high levels of foreign exchange reserves, a fiscal surplus, and initial steps being taken by Bank Indonesia to strengthen the financial sector,” the report said. In a section about the “low-case scenario” of a “severe economic shock,” the report said the probability was “currently very low” and conceivable only if a host of political, social, financial, regional, and trade risks “all materializ[ed] at once.”
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