The Chastening

by Paul Blustein

  De Tray, the World Bank’s resident representative in Jakarta, presented and defended the report at the Board meeting, although he didn’t write it. “I have rarely been more wrong,” he said later.

  Sudradjad Djiwandono, the governor of Bank Indonesia, was the toast of Asia’s financial elite in early summer 1997—indeed, he was one reason for the rosy report de Tray presented to the World Bank’s Board. Here was a central banker who seemed to know the sensible way to respond when sellers of his country’s currency flooded into the market. The drop in the baht was driving currencies downward all over Southeast Asia amid concerns that Thailand’s neighbors were afflicted with similar problems, but Sudradjad adopted an approach that set him apart. Whereas his counterparts at the Bank of Thailand had run out of hard currency battling to defend the baht at a set value, Sudradjad, a mild-mannered, fifty-nine-year-old Boston University Ph.D., took a flexible stance while Bank Indonesia still had its $20 billion stash of reserves. As if casually shrugging that his pride wasn’t on the line, he widened the range by which the rupiah could fluctuate against the dollar, to a 12 percent potential swing, on July 11. The results were hailed in a Jakarta-datelined Wall Street Journal article published July 21, which called the rupiah “an island in the storm”—its 3.4 percent decline in value that month was much smaller than those of neighboring countries’ currencies—and credited Indonesia’s “deft macroeconomic management.” Bank Indonesia’s policies were “a model for developing economies,” Neal Saker, the regional economist for Socgen-Crosby Securities in Singapore, told the Journal, which added, “Most economists think the pressure on the rupiah is a temporary spillover from the regional sell-off, and that the rupiah will rebound as the speculation subsides.”

  But in late July and early August, the rupiah’s drop accelerated as gloom in the region intensified, and after consulting with Suharto, Sudradjad decided the time had come for a bolder move. Much of the Indonesian business and financial establishment was on hand August 14 for the start of a two-day conference, entitled “A Commitment to Progress,” commemorating the twentieth anniversary of the establishment of the country’s capital markets. The president delivered a speech earlier than scheduled, apparently so that he could leave before Sudradjad spoke, because the central banker had a bombshell to drop: After more than a decade of keeping the rupiah closely linked to the dollar, a pillar of Indonesian economic stability, the central bank was scrapping the policy and would allow the rupiah to float.

  Sudradjad’s reasoning, which was widely endorsed then (by the IMF, among others) and seems sound now, was that it was crazy to squander the nation’s reserves of hard currency fighting a losing battle to keep the rupiah tied in any formulaic way to the dollar. But, he recalled, “After my speech, I started already to become more worried, because a lot of Indonesian businessmen and women came up to me, and said, ‘Mr. Governor, how could you do this?’”

  Like their Thai counterparts, Indonesian corporations had borrowed heavily from foreign lenders, to take advantage of lower interest rates overseas. Whereas it might cost them 18 percent per annum or more to borrow rupiah from an Indonesian bank, they could borrow dollars from foreigners at less than 10 percent and convert the proceeds into the rupiah they needed. It was obviously economical—and, they thought, safe. The rupiah wasn’t rigidly fixed against the dollar, but the central bank had kept the currency’s rate of decline predictable, about 3 to 5 percent a year. So with the rupiah that Indonesian companies earned on their business transactions, they could repay their foreign loans and still come out ahead.

  For foreign financial institutions, too, the deal looked too Juicy to pass up, and in the 1990s, Indonesia’s capital markets—which had always been fairly open—drew a rising tide of money from abroad, averaging 4 percent of GDP from 1990 to 1996, attracted by the twin appeals of high returns and Southeast Asian dynamism. Some of this money was lent in the form of bank-to-bank loans as in Thailand; much of it also went directly to Indonesian corporations in a complex array of forms including straight bank loans, bonds, and commercial paper.

  But as rewarding as this game was for both sides, there was a huge catch: If the rupiah fell sharply, the burden for Indonesian borrowers of repaying their foreign loans would increase dramatically. Sudradjad asked the business executives he spoke with at the conference whether they had taken the prudent step of hedging themselves against a drop in the rupiah by purchasing contracts in the currency markets ensuring that they could obtain dollars at a reasonable rate. “It was shocking to me, because their answer so often was ‘Of course not,’” he said.

  Shocking was the right word. Nobody—not Bank Indonesia, not the IMF, not the World Bank—seemed to have the faintest idea about what had suddenly become a hugely troubling question: How many dollars would Corporate Indonesia have to obtain in the next few months to pay its foreign creditors what it had borrowed? Official debt statistics were available, of course, and they showed that the Indonesian banks and companies owed about $55 billion to foreigners. But it also mattered a great deal whether the Indonesian firms had gone to the expense of buying hedging contracts to cover themselves against the potential cost of a rupiah decline. Everyone knew that a key factor responsible for the Thai baht’s fall was the dash for dollars by Thai companies that had borrowed heavily from overseas and failed to hedge themselves against currency fluctuations. So government officials, brokerage houses, and credit analysts in Jakarta began calling Indonesian corporate executives and marshaling data as fast as they could to determine whether Indonesia was similarly exposed.

  The answers weren’t comforting. Jakarta brokerage firm reports, which once were full of starry-eyed prognostications about endlessly expanding horizons in the country’s rapidly growing market, were suddenly focused on whether Indonesian companies were at risk of being unable to pay off their dollar loans. The investment firm SBC Warburg Dillon Read published an analysis in autumn 1997 that ranked major publicly traded companies according to how much they had borrowed from abroad and what percentage of their debt had been hedged. A few, like H. M. Sampoerna, a maker of clovescented cigarettes, had paid for full hedges. But many others had followed the example of Indofood, the giant noodle maker controlled by Suharto crony Liem Sioe Liong, which had borrowed $600 million from abroad without bothering to hedge itself at all, according to the report. “The demand for US$ to cover unhedged borrowings has been far greater than first thought by [Bank Indonesia], or by private sector analysts,” the report warned. “Market sources suggest that as much as US $30bn could still be waiting to be covered.... [T]he implications for the IDR [the rupiah] are clear—and ominous.”

  In other words, Indonesia was vulnerable to a vicious cycle taking hold in the markets. Any unhedged Indonesian company owing debt to foreigners might feel compelled to scramble for dollars, for fear that if the rupiah fell further, the burden of repaying the debt would increase. And the scrambling for dollars would cause the rupiah to drop, which would induce more scrambling, and so on.

  That basic scenario started playing itself out beginning in September 1997, as people and companies became increasingly aware of the danger and began trimming their exposure to a further drop in the rupiah. Some of these were foreign banks pulling short-term credit lines to Indonesian borrowers. Additional participants in rupiah-selling, though virtually impossible to trace, were members of Indonesia’s ethnic Chinese minority, who were starting to worry about the prospect of social unrest and wanted to move some money abroad. The Chinese had been frequent scapegoats of the Muslim majority, most notably during the bloody tumult of 1965-1966 that eventually brought Suharto to power, as dramatized in the film The Year of Living Dangerously.

  A distraught Suharto could not understand what was happening to the rupiah, which had been worth 2,400 per dollar early in the summer but closed below the 3,000 rupiah-per-dollar level on September 2 and dropped to 3,400 on October 1. Though not outspoken on the subject like Malaysian Prime Minister Mahathir Mohamad, who
railed publicly about a plot behind the attack on Southeast Asian currencies, Suharto shared Mahathir’s suspicions. “Many times he kept asking me, ‘What is the role of all these speculators?’” Sudradjad recalled.

  It was against this backdrop that Indonesia, once again surprising the markets, turned to the IMF in the first week of October, and the mission led by Bijan Aghevli rushed to Jakarta. Exactly how Suharto was persuaded to invite the Fund, and whether he understood what sorts of demands might be made on him, remain open questions. He was evidently told that the IMF program would be precautionary and that it was needed for confidence purposes. At the same time, several top members of Suharto’s economic team were confiding to U.S. and IMF officials that they wanted the Fund to impose a number of reforms they had long favored, and some of these policymakers, notably the passionately upright finance minister, Mar’ie Muhammad, favored an attack on the monopolies and subsidies that had flourished thanks to KKN.

  Suharto must have had some basis for believing that the Fund wouldn’t be highly confrontational, because the IMF mission started off operating under a similar assumption. Its initial brief suggested that because the program was to be precautionary, the mission should give the benefit of the doubt to Indonesian negotiators, who were likely to be proreform anyway. But in the three weeks that it took to complete the negotiations, the Fund substantially changed course toward demanding extensive anti-KKN conditions from the Indonesians.

  The reason for the turnaround was pressure from members of the IMF board representing Western industrial countries. Karin Lissakers, the U.S. representative, was particularly assertive. In addition to hearing from proreform Indonesian technocrats, the Clinton administration was getting an earful from nongovernmental organizations—primarily religious and labor groups, both Indonesian and Western—who wanted to see the IMF’s leverage used to attack KKN. Administration officials began to educate themselves on matters such as how BULOG, the state agency responsible for the distribution of many key foodstuffs and raw materials, helped enrich certain Suharto cronies, and they realized that a bailout of Indonesia would be criticized if it appeared to tread too lightly on the problem. Thus they wanted reforms to extend well beyond the typical Fund program, which normally would be confined to fixing macroeconomic problems such as excessive government spending: “The mission went out [to Jakarta] with the usual recipe—tweak a little on monetary policy here and fiscal policy there,” Lissakers recalled. “We stepped up the heat, the more we found out about the issues, hearing about these massive subsidies to cronies and family members.” The Fund’s traditional mandate didn’t encompass such matters: “This was clearly pushing the outside of the envelope,” she acknowledged.

  The one G-7 member that objected to this line of thinking was Japan, whose vice minister of finance for international affairs, Eisuke Sakakibara, flew to Jakarta on October 16 to press the argument that Indonesia’s crisis had little to do with crony capitalism and much to do with the vicissitudes of global capital. Sakakibara recalled that he “had a heated discussion” lasting about two hours with mission chief Aghevli, “but Aghevli did not give in. We failed to win concessions from Aghevli even though we threatened that the Japanese government would act on its own if its opinions were ignored.”

  Aghevli had largely accepted the view that the program should place heavy emphasis on structural reforms. But the pressure from Washington for more concessions from the Indonesians made life difficult for the IMF team in Jakarta, which constantly had to up the ante in the negotiations. Urgent messages to Aghevli’s mission were streaming into Jakarta almost daily from Hubert Neiss, who was attending IMF board meetings at which Lissakers and others were urging additional conditions for inclusion in the program. Accordingly, instead of doing what negotiators normally do—start off with a tough position and gradually yield ground—Aghevli and his colleagues kept insisting on more conditions as time went by. Their Indonesian interlocutors generally liked the reforms on substantive grounds, but they were faced with the daunting challenge of obtaining Suharto’s assent.

  The pressure on the mission to reach a satisfactory deal increased from intense to acute when currencies and share prices all over Asia nose-dived the week of October 20. The strain would take its toll in a variety of ways, not the least of which would be wretched relations between the IMF and its supposed partners in the multilateral development banks.

  The Grand Hyatt, Jakarta’s premier deluxe hotel, looms over one of the most congested traffic circles in a steamy, smoggy city whose avenues are lined with boxy office towers and grandiose monuments. The IMF mission led by Aghevli stayed there in October 1997, setting up a command center on the exclusive Regency Club floors.

  The IMF and the World Bank had started off cordially enough in working to resolve the Indonesian crisis. The Fund, recognizing the World Bank’s expertise in financial-sector issues, asked it to send some of its financial specialists along on the mission, and among those dispatched to Jakarta were individuals with knowledge of Indonesia’s banking system, including a member of Lily Chu’s team who had worked on assessing the ill-starred state-owned bank project. The World Bankers Joined the IMF team at the Grand Hyatt.

  But once the group was in Jakarta, hopes of cooperation evaporated amid infighting, mistrust, and differences of opinion, not only between the Fund and the Bank but also between the two institutions and the Manila-based Asian Development Bank (ADB), which also sent specialists to Jakarta in preparation for its contribution to the Indonesia bailout. (Like the IMF and World Bank, the ADB is owned by governments.) “The mission from hell,” one participant called it.

  The World Bankers and the ADB staffers complained bitterly to their colleagues that the Fund was shunting them aside, keeping them in the dark and ignoring their perspectives. IMF staffers often refused to let their World Bank and ADB colleagues see draft versions of the Letter of Intent—the document spelling out the promises the Indonesian government would make in exchange for a loan—asserting that the material was confidential and couldn’t be viewed by anyone outside the Fund. Even when the World Bankers themselves wrote memos at the request of the Fund, they were told they couldn’t have their own material back because once handed over, the documents became confidential.

  Logistical snafus exacerbated tensions. Although the IMF and Washington-based World Bank staffers were ensconced at the Grand Hyatt, their ADB colleagues labored under expense-account guidelines that couldn’t accommodate the room rates there, so they had to book into a hotel across the busy traffic circle. That often made it difficult for the ADB team members to learn of key meetings, and as time went on, it was impossible to distinguish which meetings they were intentionally excluded from—and which they were inadvertently not invited to. The antagonism and mutual suspicion grew. To make matters worse, the word-processing software the IMF used was WordPerfect, but the software in the World Bank laptops was Microsoft Word, so the two institutions’ computer systems couldn’t easily exchange files and documents—a perfect metaphor for their broader breakdown in communications. The World Bank and ADB, meanwhile, battled constantly over which agency would have control over certain issues—with tempers flaring so openly that Indonesia’s deputy finance minister, disgusted by the bickering, stormed out of a meeting.

  So furious were ADB staffers over their treatment by the IMF that two of the bank’s senior officials, Shoji Nishimoto and Paul Dickie, wrote to Hubert Neiss warning that the ADB would go it alone in the future rather than work with the Fund on Joint missions. (In fact, the ADB ultimately did Just that in Indonesia in late 1997 and early 1998.) “The ADB representatives were not notified of many of the discussions and were not kept informed of the overall progress of negotiations, and comments provided by the ADB participants were ignored,” they said in their letter dated November 13. “Furthermore, we have not as yet received any documents pertaining to the Mission. Our experience in this Mission means that we would be very reluctant to participate in any future miss
ions with [the Fund’s Monetary and Exchange Affairs Department].”

  The Monetary and Exchange Affairs Department (known within the Fund as MAE), which was the focus of many of the complaints by the World Bankers and ADB staffers, had its own mission chief in Jakarta, Reza Vaez-Zadeh, an Iranian national. The department is a small but rapidly growing part of the Fund specializing in financial-sector issues that began expanding in the 1990s in response to mounting concerns about the dangers that weak banking systems posed in many countries. The World Bank staffers from Washington were formally assigned to Vaez-Zadeh’s unit and found themselves cut off from much of the central decisionmaking, since all bureaucratic communication had to go through Vaez-Zadeh, in keeping with practice at the hierarchical Fund. All of this was particularly irksome to the World Bankers because they believed their grasp of the situation in the Indonesian banking system—a grasp based on in-depth scrutiny of banks and loan documents—far exceeded that of the Fund’s economists. The Fund had sent missions from Vaez-Zadeh’s department to Jakarta before to look at the banking sector’s problems, but those missions had focused predominantly on Bank Indonesia—talking to government bank regulators and poring over official reports on the health of the banks, gathering evidence that the World Bankers had concluded was of little use and tainted with corruption.

  There were other flashpoints as well, in particular between the IMF’s main mission from the Asia and Pacific Department, led by Aghevli, and the World Bank’s resident representative’s office, headed by de Tray. The IMF was clearly in control of the negotiations with the Indonesians, and de Tray’s operation was fuming that it wasn’t being consulted even though the World Bank was expected to contribute a hefty sum to the package. Part of the problem was that the IMF staffers were working into the wee hours at the Grand Hyatt, communicating with Washington by e-mail or phone, so they could get approval for decisions and receive their orders in the morning. What were they supposed to do, they wondered—invite the World Bank staffers living in Jakarta to spend the night in their hotel rooms writing memos together?