The Guardian [UK]

Wednesday September 8, 1999

Loans to Jakarta test nerve of west


Refusing help to Indonesia risks Asian meltdown

Alex Brummer

Just as the western industrial powers and their economic arm, the International Monetary Fund, were allowing themselves a moment of self-congratulation at having tamed the 1997-98 Asian meltdown, along comes the return of barbarism to East Timor.

A semblance of democracy had appeared to be returning to Indonesia: hopes were rising that with IMF and World Bank loans of $43bn the calamitous decline in economic growth and living standards could be reversed, and with it political stability ensured.

Next weekend's meeting of the Asia Pacific Economic Conference (Apec), to be attended by President Clinton and Asian leaders, had been expected to focus on strengthening democratic institutions, renewing growth and working on an ambitious free trade agenda for the region. Instead, the focus has shifted rapidly.

The west finds itself in the dock over its past arms sales to the region made in the name of strategic stability during the cold war years. In addition, the country and its institutions are very much a western creation: its strong, conservative crony-capitalism was adopted by Sukarno when he helped win independence for the country in 1945, and was carried on by General Suharto when he took power in a military coup in 1966. BJ Habibie, who was handed power by Suharto last year after widespread rioting, has continued such policies.

Although much of the immediate focus has been on the west's sales of arms, far greater investment has been made in Indonesia's low-cost and entrepreneurial workforce. Some of Britain's biggest banks notably HSBC, Standard Chartered and the Royal Bank of Scotland have large sums of money riding on the return of growth and financial stability to Indonesia. They are not alone.

The banking towers that dominate the Jakarta skyline are a monument to western support for Indonesian capitalism. Japanese and US banks have the biggest exposures.

These banks have started long and complex negotiations with Indonesia's main companies, such as the diversified conglomerate Bakrie & Brothers, in an attempt to sort out debts of $1.15bn.

The financial state of Indonesia is so precarious that even the mildest political tremors could send the economy back to the worst days of 1998, when gross domestic product plummeted by 16%, making the country a worse basket case than even Russia.

The strategic importance of Indonesia has long been recognised by the west. In the second world war one of the key allied objectives in the Pacific was to block Japanese access to what was then the Dutch East Indies, with its natural resources including oil.

In more modern times importance has been conferred on the country by its size and scale. It is one of the most populace countries in the world, with 204m people living on hundreds of islands with a surface area of 1,905 sq km, two-thirds of the land mass of India. The country's shrinking gross domestic product of $138.5bn makes it the 28th largest economy in the world.

In the period 1989-93, when the Asian model was being lauded throughout the west, Indonesia enjoyed economic expansion on an impressive scale: growth climbed by 7% a year. But as Jeffrey Henderson of the Manchester Business School has observed, despite a veneer of success, it was among the "industrially least advanced of the East Asia economies".

It rode partly on the back on Japan, which gradually priced itself out of world markets. As the big car companies shifted production to much lower cost countries such as Indonesia, Japan ended up with an enormous financial stake in preserving the country's stability.

The US in particular regards Indonesia as one of the critical states in the Pacific basin. In recent decades the US, first under Ronald Reagan and subsequently under George Bush and Mr Clinton, has sought to give its foreign policy a Pacific tilt.

But as the Asian economic miracle developed over the last decade, the US also began to look to its Pacific rim for its economic relationships. It was instrumental in helping to create Apec, in what was seen as an economic counterbalance to the European Union.

It was this shift that led to an anxious Europe creating its own alternative forum Asem, the group of Asian/European finance ministers. But whereas Apec is a policy-making body pushing for the creation of a free trade area across the Pacific, Asem is no more than a loose consulting mechanism.

America's intricate involvement in Indonesia, particularly in its reconstruction after last year's economic crisis, means that it is in a position to force the west's will on Jakarta. President Habibie's regime has largely sustained its legitimacy at home and overseas by persuading the US that, however flawed it may be, it is deserving of western financial support.

The power of the purse strings cannot be underestimated. Decades of trade and arms embargoes in apartheid South Africa did little to force Nationalist governments to cede their grip. It was only when congress forced US financial institutions to pull out that South Africa's then-president, FW de Klerk, realised the game was up.

There are already the first indications that the west, as much as it wants to avoid a second financial collapse in Indonesia, may be contemplating using its ultimate power. The IMF, which leads the $43bn mission to prop up the country's economy, says it is watching the situation closely. It makes its loans on a phased basis as various economic conditions are met. The economic criteria are constantly under scrutiny. In Russia it halted loans last year, and it could take similar action in Indonesia.

Although the Fund prides itself on being an economic institution impervious to political conditions, the US as the largest shareholder can with the support of other G7 countries bring an immediate halt to western finance.

The World Bank is intimately involved too. By March this year the Bank's lending to Indonesia approached $25bn, of which $19.8bn had already been advanced.

Under its current president, James Wolfensohn, the Bank has sought to use Indonesia as a test bed for new standards of good governance and transparency. It has become involved in almost every aspect of the Indonesian economy, from the banking system to health care projects and educational schemes. It seeks to hold the Jakarta government to its promises by publishing agreements on the internet and focusing on parts of the economy such as social security and corruption, which in the Suharto years were considered untouchable.

The Bank's insistence on better governance has meant it has been scrupulous in its dealings. Earlier this year it held up a negotiated $600m budget support loan to the government because it feared that some of the funds might find their way into the pockets of the pro-government parties before the June 7 elections.

Although in the past it has been widely criticised for helping to prop up authoritarian and corrupt regimes through generous loan programmes, now it is as likely to halt programmes in response to the complaints of protesters or non-governmental organisations.

This means, in effect, that both the IMF and the World Bank ought to be very sensitive to the present standoff in East Timor and prepared to freeze, if not halt, lending on the grounds that the money could easily be redeployed to pay the militias and security forces responsible for the bloodshed in East Timor.

The west is plainly concerned about using the financial weapon in Indonesia because of its broader implications. The Jakarta stock market slumped 4% on Monday as the crisis deepened. The risk is that contagion will set in across the region and that the whole of the Asian economic recovery could be jeopardised.

How the world bought its stake

International loans

The IMF, the World Bank and western governments bailed out the Indonesian government with a 20.6bn ($33bn) loan, after the rupiah was hit by the Asian financial crisis in autumn 1997. Not all of the money was disbursed after the government dragged its feet on economic reforms the IMF demanded in return for the bailout. But the World Bank lent an additional 12.5bn ($20bn) for other development projects. Indonesia currently owes the Bank and the IMF 12.75bn, and about 13.5bn to western governments.

Commercial bank loans

The rupiah's fall burnt many western banks, including HSBC, Standard Chartered, Schroders, NatWest and Barclays, which were large lenders to Indonesian companies. At the end of last year Indonesia owed western banks 30.75bn.


France and Britain are the biggest exporters of arms to Indonesia. UK exports last year were worth 112m and French exports roughly double that figure.

Oil and natural gas

Indonesia produced about 1.5m barrels of oil a day last year, just over 2% of world output. Caltex, a joint venture between US companies, Chevron and Texaco, is the biggest oil producer in the country. The state-owned oil company, Pertamina, lost its monopoly over awarding contracts to foreign firms earlier this year after corruption over the deals was exposed.


Indonesia attracted 3.9m visitors last year, who spent the equivalent of 3.8bn.

World Bank

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