Indonesia, the Philippines, Malaysia, Thailand, and South Korea were hit by the monetary crisis in 1997–1998. Of the four, Indonesia was listed as the country with the slowest economic recovery process.
Six years after the crisis, Indonesia's GDP had not fully recovered from pre-crisis levels. GDP per capita was still 10 percent below 1997 levels.
Compared to other countries, Indonesia's situations during the crisis were indeed the most complicated. The foreign debt was bloated. The banking system was weak. The economic governance was bad that caused a high-cost economy, plus the absence of political stability, as well as complicated practices of corruption, collusion, and nepotism.
The New Order government at the onset of the crisis was also considered to be halfhearted in implementing the reform program compiled together with the IMF team.
Thee Kian Wie in The Emergence of a National Economy said that the New Order government's half-hearted attitude was evident from the failure to implement economic reform programs. One of them was a program to remove barriers to domestic competition, including the clove monopoly managed by Tommy Suharto. The Indonesian Bureau of Logistics also had a monopoly on imports of a number of products.
One of the causes of the complications of the 1997 Asian financial crisis was the breakdown of the national banking system. Unhealthy banking practices were carried out, taking advantage of the existing regulatory loopholes that undermined the strength of the system.
The vulnerability of national banking resilience to crises was caused by internal conditions, for example, the concentration of credit in certain economic sectors, especially to parties affiliated with banks.
Banking conditions were exacerbated by the absence of guarantees for customer funds, weak law enforcement, problems with central bank dependency. These things created a moral hazard for bank management. As a result, they dared to take high risks.
When the monetary crisis came, the handling of banking became a top priority, considering that this sector was both a heart and a source of damage. The agreement between the IMF and Indonesia at an early stage underlined this. After conducting a diagnosis of Indonesia's economic condition, the IMF finally gave three recipes, which were outlined in the first letter of intent (LoI). One of them was fixing the banking sector by closing 16 sick banks.
Initially, the IMF recommended the closure of 34 sick banks. However, BI conducted negotiations to reduce the number of closed banks until finally an agreement was reached for 16.
Unfortunately, this decision triggered a rush or massive withdrawal of funds. The main objective for improving the banking sector had not been achieved. Situations were getting out of hand.
One of the reasons for the failure of the bank reform program was that the available information on banking was inaccurate and different from reality. Only a number of banks, which were generally relatively small in size, were truly unhealthy while the rest were healthy or mildly ill.
The closure of 16 banks further confirmed to the public that the national banking condition was not healthy. Depositors chose to withdraw their funds from banks, causing liquidity dryness. Most of the funds withdrawn were used for foreign currency speculation, which resulted in further pressure on the rupiah exchange rate.
Withdrawal of customer funds was not only in cash but also through clearing. Therefore, many banks had negative current balances in BI, which then tightened liquidity to prevent them from participating in foreign currency speculation.
One of the reasons the rush was unstoppable at that time was the absence of a full guarantee for bank deposits. The new government announced guarantees for deposits below 20 billion rupiahs a few moments later. The announcement still failed to overcome the rush.
Several years later, the IMF concluded that it would be possible to reduce panic if a full guarantee system for deposits were implemented. The full guarantee itself was only implemented in early 1998 after the situation worsened and developed into a total banking crisis.
The rush and also the tightening of liquidity triggered an increase in interbank interest rates to an average of 60 percent per year. Then there was a domino effect. The lending banks were experiencing liquidity difficulties. As a result, there were more banks with negative balances in BI.
Repairing an already crisis banking system was very complex. In the early stages of banking reform, the government took preventive steps to reduce the impact of damage to the system. Banks that were sick and deemed capable of causing damage to the banking system were frozen and taken over.
On April 3, 1998, the government designated seven banks as frozen-operating and seven other as taken-over (BTO). In August 1998, three other banks were designated as BTOs.
Furthermore, on August 21, 1998, the government announced two comprehensive banking restructuring packages. The first package was recapitalization and improvement of banking rules and regulations. The second package was to accelerate bank restructuring.
After the program was implemented, on March 13, 1999, it was decided that 38 banks became frozen for business activities, seven were BTO. Meanwhile, nine national private banks, 12 BPDs, and all state-owned banks were included in the recapitalization program.
As part of overcoming this banking problem, on January 27, 1998, the government formed the Indonesian Bank Restructuring Agency (IBRA). IBRA was tasked with undertaking a comprehensive restructuring of the national banking system, including the bank recapitalization program and the guarantee program.
IBRA then played the most important role. It managed assets equivalent to 36 percent of GDP or around 441 trillion rupiahs. This value consisted of 234 trillion rupiahs of foreclosed debts and 112 trillion in assets handed over by bank owners and 94 trillion in investment for recapitalizing participating banks.
However, the restructuring process and the sale of assets did not proceed smoothly due to legal and political problems. Most of the NPL portfolio must be sold below the minimum price set by IBRA. The amount that IBRA could return was 188.88 trillion rupiahs, meaning a recovery rate of 30.39 percent.
Another issue that must be addressed in the context of economic recovery was the restructuring of private debt. The weakening of the rupiah made it difficult for corporations to have large foreign currency debt entanglement. Worse, the debts were not hedged.
Indonesia's total foreign debt as of March 1998 was 138 billion dollars. Of this, 64,5 billion dollars was debt owned by private companies, banks amounting to 13.6 billion. Meanwhile, 12.8 billion were inter-bank loans.
Total amortization of payments due for the calendar year 1998 was estimated at 32 billion dollars prior to restructuring. Of this amount, 20 percent was debt guaranteed by the government. The remainder was private debt with two-thirds of this short-term. This amount was greater than the value of foreign reserves at that time.
With the rupiah exchange rate dropping sharply against the dollar, it was almost certain that these companies had difficulty paying off maturing foreign currency debts. For that, debt restructuring must be carried out.
Unfortunately, clearing private debt was not an easy task because there was no accurate data. In addition, the problem of private debt restructuring was not included in the IMF LoI points, so it did not get attention to be addressed. In fact, this problem had also been one of the triggers for the crisis as corporations continued to hunt down dollars for their maturing debt needs. If not controlled, it could disrupt the course of economic recovery.
Entering January 1998, the government finally began to actively participate in clearing this private debt. Restructuring negotiations were held. Indonesian debtors represented by the private foreign debt settlement team managed to reach an agreement with foreign creditors represented by the Bank Steering Committee. On June 4, 1998, the Frankfurt agreement for a private debt restructuring was reached.
The Frankfurt agreement covered the settlement of interbank loans, trade finance, and private company loans. Interbank loan settlement was conducted through an exchange offer program in the form of rescheduling of bank loans. The trade financing program was carried out by reviving the credit line after the outstanding trade payables were settled by BI. To settle private debt, the government had formed the Indonesian Debt Restructuring Agency (INDRA). To help INDRA, the government provided facilities and encouragement to smooth negotiations between debtors and creditors through the Jakarta Initiative program.
Through this restructuring, it was hoped that the company's liquidity position could be maintained. Thus, there would be no production disruptions so that there would be no layoffs, and the company could again pay its financial obligations.
It was not only banks and companies that were suffering from the crisis. The community suffered no less. The crisis caused the number of poor people to increase sharply.
The number of poor people increased from 34.01 million people to 49.5 million. As a percentage, it increased from 17.47 percent to 24.2. The poverty rate in cities increased sharply from 9.42 million in 1996 to 17.6 million in 1998. In the villages, poverty increased from 24.59 million to 31.9 million.
The crisis also led to mass layoffs, particularly in labor-intensive sectors, such as property and manufacturing. As of February 1998, the number of workers in the manufacturing sector fell 13 percent, finance seven, electricity 27.
However, dealing with these vulnerable and affected groups was not easy in the midst of a crisis and political turmoil. After Suharto stepped down and was replaced by B. J. Habibie, the government then moved to deal with this problem.
The APBN was relaxed in order to provide assistance to the poor. In the July 1998 LoI, which was B. J. Habibie's first LoI, this plan was finally realized. This APBN deficit was relaxed to 8.5 percent of GDP, primarily to finance social safety net (JPS) programs and the provision of basic necessities. This deficit was higher than the 1997–1998 state budget, which was only 0.8 percent of GDP.
To cover the deficit, the government was seeking additional debt and privatizing several BUMNs.
The actual deficit in the 1998–1999 state budget was only 2.2 percent. This was due to the realization of spending that was far below the budget due to the improvement in the rupiah, technical constraints in implementing JPS, and savings through the elimination of some subsidies. On the other hand, the revenue was mainly from an increase in income from tax of interest and in the export rate of palm oil.
The deficit financing burden was slightly reduced due to the restructuring of a number of foreign debt, which was agreed upon at the Paris Club meeting on September 20, 1998.
Various fiscal and monetary control measures were beginning to show results. In October 1998, the rupiah exchange rate was under control at around 7,000–8,000 per dollar.
In 1999, a number of Indonesian economic indicators began to show a reversal. The economic growth, which in 1998 was minus, in 1999, was able to grow even though it was only two percent. Inflation, which in 1998–1999 reached 45.4 percent, gradually decreased. In October 1998 and March 1999, there was even deflation.
The 1997 crisis was the most expensive crisis facing Indonesia. The government had no less to bear debt securities of 620.9 trillion rupiahs, consisting of BLBI fees of 144.5 trillion, recapitalization costs and others injected into banks of 476.4 trillion. This did not include losses due to millions of layoffs and increasing poverty rates.