Ross H. McLeod

The struggle to regain effective government under democracy in Indonesia

With Soehartos demise, Indonesia gained democracy but lost effective government. A return to sustained, rapid economic growth will require an overhaul of Indonesias bureaucracy and judiciary which, along with the legislatures, the military and the state-owned enterprises, had been co-opted by the former president into his economy-wide ‘franchise’—a system of government designed to redistribute income and wealth from the weak to the strong while maintaining rapid growth. This franchise has disintegrated, its various component parts now working at cross-purposes rather than in mutually reinforcing fashion. The result has been a significant decline in the security of property rights and, in turn, the continued postponement of a sustained economic rebound. To reform the civil service it will be necessary to undertake a radical overhaul of its personnel management practices and salary structures, so as to provide strong incentives for officials to work in the public interest. * Much of this paper was written while the author was a visitor at the School of Advanced International Studies, Johns Hopkins University.

Towards improved monetary policy in Indonesia

Indonesias depreciation vastly exceeded that of all other countries hit by the Asian crisis. Indonesia also experienced far higher inflation. This paper argues that there is a close medium to long-term relationship between money growth and inflation in Indonesia, and that this has not been greatly disturbed by the crisis. It argues that the countrys disappointing performance in relation to maintaining the value of the rupiah can be explained by the central banks failure to sterilise the monetary impact on base money of its last-resort lending to the banks. The fundamental lesson is that Bank Indonesia would be well advised to adopt slow and steady growth of base money as the nominal anchor for monetary policy, now that the pre-crisis policy of slow and steady depreciation of the rupiah has been abandoned.

Control and competition: Banking deregulation and re‐regulation in Indonesia

Policy changes in Indonesian banking from 1983 through 1990 saw the removal of controls on interest rates, lending, and expansion of branch networks, and of barriers to entry. The dismantling of loan subsidy programmes financed by the central bank ran in parallel with these changes. Private banks have been enabled to erode rapidly the market share of the previously dominant, but less efficient and less customeroriented, state banks. Despite the impressive progress resulting from these reforms, however, interventionist policy has been making a comeback during the 1990s, and the central bank still maintains its role as a significant supplier of subsidised loans.

Dealing with bank system failure: Indonesia, 1997-2003

Indonesias crisis recovery program has failed badly in relation to the two key objectives of development economics policy making: efficiency and equity. The economy went into severe recession within a few months of the IMF appearing on the scene, and six years later output was little higher than before the crisis. The collapse of the banking system and the associated government bailout of depositors has imposed a loss on the public of at least 40% of GDP. This paper describes that collapse and the governments policy response to it, under advice from the IMF. It goes on to propose an alternative scheme that might have been followed—and that could be followed in future banking crises. Its twin objectives are to maintain the integrity of the payments system and to avoid inequitable wealth transfers that result from government bailouts of banks and their depositors.

Lessons for monetary and banking policies from the 1997-98 economic crises in Indonesia and Thailand

There is little disagreement that the Asian crisis would not have happened if the financial systems of the affected countries had not been vulnerable to panic and speculative attack (Corsetti et al., 1998; Radelet & Sachs, 1998). Nor is there much disagreement about the factors that helped trigger the attack: because of the generally poor performance of the Japanese economy in 1996–97 and strong competition from China, most other Asian countries experienced a reduction in the demand for their exports. This was exacerbated by the loss of export competitiveness resulting from the weakening of the yen relative to the dollar, given that most Asian currencies had been pegged to the latter. This slowdown in export growth was particularly marked in the case of Thailand, although much less so in Indonesia. A mood change against the excessive optimism of the earlier boom appears also to have been important. The second generation speculative attack models help to illustrate the kinds of mechanisms that were probably at work. 1 If the government is expected to respond to bank failures by bailing out depositors—and to finance this by money creation for fear that any increase in interest rates due to selling securities would cause bankruptcies and further bank failures— then in conditions of financial vulnerability any small trigger can induce self-fulfilling expectations of bank and corporate losses, monetary expansion, capital outflow and devaluation. Such vulnerability will exist if long-term investments have been financed by short-

Explaining chronic inflation in Indonesia

This paper describes and analyses Indonesias frustrating experience with chronic inflation, and demonstrates that the cause of continuing moderately high inflation is excessive growth of base money. It examines the central banks current target growth rates for narrow and broad money and bank lending, and argues instead in favour of a single target rate for base money as the key to bringing inflation under control.

Civil society organisations' contribution to the anti-corruption movement in Indonesia

Abstract Soeharto era concern about corruption was deflected by the establishment of toothless anti-corruption committees, and by suppression of anti-corruption activism and media comment. With Soehartos demise, activists began to publicise their concerns more openly – at first speaking in general terms, but later making increasingly specific allegations. The sporadic activism of the Soeharto years was consolidated, first through cooperative action among similarly motivated informal groups, and later through establishment of formal civil society organisations (CSOs) intent on rolling back corruption. The CSOs have played a key role in pushing for new laws and institutions to help eradicate corruption, and many corrupt officials have been imprisoned. This paper finds little evidence, however, that corruption has declined significantly. It argues that further progress depends on CSOs gaining a better understanding of the underlying causes of corruption, and that these are to be found in public sector personnel management practices.

Inadequate budgets and salaries as instruments for institutionalizing public sector corruption in Indonesia

Soeharto used the Indonesian bureaucracy to generate rents that could be harvested by ‘insider’ firms, while also encouraging it to extort money from ‘outsider’ firms and individuals. This necessitated incentives that would ensure strong loyalty and minimize internal opposition. Government entities were provided with insufficient budget funding to cover their costs, and their officials were expected to generate cash from illegal activities, making public sector employees financially dependent on corruption. Any employee who opposed this system could expect to be restricted to earning no more than the pitifully low formal salary entitlement. The system therefore became strongly self-reinforcing.

Postscript to the Survey of Recent Developments: On Causes and Cures for the Rupiah Crisis

The dramatic fall of the rupiah has been driven largely by panic, rather than by careful analysis of Indonesias economic fundamentals The catalyst for the panic appears to have been a sudden reassessment of the exchange rate risk faced by unhedged domestic firms and foreign investors This reassessment was triggered by the abrupt decision of the That government to float the baht. The policy focus now must be on helping the private sector adjust to the floating rate environment, and aiming to maintain economic growth. Belt-tightening measures are counterproductive in these circumstances. The process of adjustment might be assisted by a clearly articulated decision by the government for Bank Indonesia (BI) to divest itself rapidly of a large portion of its foreign exchange assets, given that its need for them is greatly diminished in a genuinely floating regime.

Crisis-Driven Changes to the Banking Laws and Regulations

This note discusses some implications of amendments to the 1992 banking law enacted in November 1998, of the new law on the central bank enacted in May 1999,1 and of various changes to the banking prudential regulations introduced during 1998. Many of these changes were precipitated by the current crisis, but the extent to which some of them will assist recovery or contribute to avoiding future crises seems limited.