Errors Made in Indonesia Policy, IMF Concedes

The International Monetary Fund has conceded that some of its earlier prescriptions for rescuing the Indonesian economy backfired and inadvertently may have contributed to the collapse of the banking system here, international officials said today.

In a confidential report, the fund’s senior staff said IMF demands in October that Indonesia raise interest rates as part of its recovery program apparently conflicted with simultaneous instructions that the government shut down 16 large, insolvent banks.

When both policies were put into place at once, at IMF insistence, the move unexpectedly squeezed many healthy banks as well and exacerbated the pressures on the banking system, the document said. That in turn set off a new wave of capital flight.

Disclosure of the unintended gaffe, contained in a 17-page report distributed to the IMF’s executive board in Washington last week, marked the first formal admission by the 181-country organization that some of its prescriptions here may have backfired and hurt Indonesia.

However, officials said the report was not an indictment of IMF prescriptions for other Asian countries caught up in the current turmoil, and they added that the fund was not on the verge of revamping its entire strategy, despite complaints by some critics that it has proven counterproductive.

Even as the IMF report was circulated, many Asian currencies and stock markets continued to rebound today. Singapore’s main stock index was up 7.4% at midmorning after soaring 7.7% on Tuesday. Malaysia’s main stock index gained 6.1% early today, and Indonesian stocks were up 2.3% today after rocketing 9% on Tuesday as Indonesia’s currency, the rupiah, strengthened.

The confidential report said fund officials had been faced with “conflicting objectives” in dealing with the Indonesian economy--a need to prod the country into protecting its currency while at the same time strengthening its banking system by closing insolvent banks.

In a move that IMF strategists believed would bolster confidence in the financial markets, Indonesia closed down 16 insolvent banks, including one that authorities say was owned by one of President Suharto’s sons. The idea was to purge the banking system of its worst offenders.

However, the report concluded, “these disclosures, far from improving public confidence in the banking system, have instead set off a renewed ‘flight to safety’ ” that has squeezed the banking system even further and may have contributed to the failure of some weak but viable banks as well.

The disclosure came as the beleaguered Indonesian government moved swiftly Tuesday to hammer out an emergency economic reform program in hopes of winning formal approval from the IMF on Thursday, when the agency’s managing director arrives for talks with Suharto.

Although details of the plan are not complete, negotiations between senior Indonesian officials and IMF representatives were proceeding apace without major snags. Insiders said a formal announcement might be made Thursday.

The joint effort came after a two-day visit by a team of senior U.S. officials, headed by Deputy Treasury Secretary Lawrence Summers, that underscored American concern about the financial turmoil in Indonesia. The U.S. officials urged Suharto to comply with IMF demands.

The 76-year-old president reportedly assured Summers that the Indonesian government will make reforms required in October by the IMF and, in some cases, even exceed them.

“It is clear that President Suharto recognizes the need to take strong steps of the kind that have been under discussion with the IMF to breed confidence and to build on the very strong foundations for prosperity that Indonesia enjoys,” Summers told reporters before leaving Indonesia on Tuesday.

The U.S. mission, accompanied by similar calls for reforms by a bevy of other foreign leaders, was designed to increase confidence in financial markets enough to stem the continued slide in the value of Indonesia’s currency, which has been sending stock prices plummeting.

U.S. officials had feared that unless the slide could be stopped soon, the turmoil would spread to other financially troubled Asian countries and worsen the economic situation throughout the region, eventually hurting the United States and other industrial economies.

The effort paid off after Suharto indicated Monday that he will accede to the IMF demands.

Summers went on to Malaysia and Thailand on Tuesday to meet with senior officials there. He is to make other stops in Asia, including China and South Korea.

Meanwhile, Goh Chok Tong, Singapore’s prime minister, arrived here Tuesday for talks with Suharto to emphasize the U.S. and IMF message.

Singapore has close economic ties to Indonesia and has played a key role in Suharto’s seeming turnaround.

Senior officials here reacted swiftly in the wake of Suharto’s new willingness to adhere to IMF policies. Finance Minister Mar’ie Muhammad announced that the government will get its budget into line; Industry and Trade Minister Tungki Ariwibowo spoke of cutting import barriers.

State Secretariat Minister Murdiono said Indonesia and the IMF were on the same track.

“In short, we will see how we can quickly revive confidence in the rupiah and carry out the reform and restructuring program,” he said.

IMF Managing Director Michel Camdessus is to meet Thursday with Suharto. Camdessus has been making a whirlwind tour of financially troubled countries. On Tuesday, he was in Seoul, seeking to increase public support for IMF reforms there and praising the government’s efforts as “the beginning of recovery” for South Korea.

There was no indication what specifics will be in the Indonesian reform package. But IMF officials have said Jakarta must reduce its budget deficit, shore up its banking system and halt several expensive infrastructure projects that mainly benefit Suharto’s family.

Officials acknowledge that these steps are likely to be politically painful. For example, an IMF requirement that Indonesia eliminate government subsidies for fuel is expected to quadruple gas prices.

Indonesia has been remarkably quiet during the visits by foreign dignitaries this week. On Tuesday, about two dozen students chanted slogans and held up banners outside the Finance Ministry when Summers held talks there. No arrests were made.

Analysts here noted that whatever good the economic and financial reform measures may do, they still will not address Indonesia’s political uncertainties--not the least of which is who will succeed Suharto if he dies or steps down. The retired army general, who has ruled Indonesia for 32 years, is ill and said to be ready to move aside but has not yet named a successor.

On Tuesday, the chairman of Suharto’s ruling Golkar party formally named Suharto as its candidate for a seventh term as president but conspicuously did not designate a candidate for vice president--a move that might have eased anxiety on the succession issue.

Defense Secretary William S. Cohen expressed confidence today after meeting with Suharto that Indonesia will regain its economic footing and avert a potentially dangerous political upheaval.

“The president indicated that he is committed to rebuilding confidence in the economic situation here,” Cohen said.