I’m Shocked, Shocked, to find that Cronyism is going on in East Asia

Like many other Asian countries, Indonesia has fallen from economic grace over the past seven months. But in the last few weeks, its condition worsened much more than elsewhere. Intervention by the United States and the International Monetary Fund produced an announcement of a dramatic reform package in Jakarta. But there are real risks here for Indonesia and for the rest of the world.

In Indonesia’s highly centralized political system, much depends on the position of the president. Former Gen. Suharto has ruled the country for 32 years, maintaining a firm grip on power. Although his regime has been associated with autocratic politics and widespread corruption, it has also steered the country through major economic crises and delivered high-speed economic growth.

Once the currency crisis broke in Thailand last July and began spreading through Southeast Asia, few Indonesia watchers were surprised when Suharto’s government moved quickly to introduce a series of preemptive reforms. Indeed, Indonesia won praise from investors for acting decisively when other governments in the region procrastinated or blamed foreigners.

As it turned out, Indonesia’s problems ran much deeper than initially thought. Following the devaluation of the national currency, the rupiah, many Indonesian firms that had borrowed heavily in dollars had to scramble to buy dollars to meet their increased debt obligations. This accelerated the fall of the rupiah. By early October, it was clear that Indonesia could not fight the problem on its own, and the IMF was called in.

The IMF announced a major bailout package in return for further economic reforms from the Indonesian government. This brought some respite, but the gains proved short-lived. In the weeks since early November, the rupiah slipped, slid, then went into free fall as uncertainty about Suharto’s leadership snowballed.

A number of factors have combined to create this environment of mounting political uncertainty. One was Suharto’s apparent backsliding in implementing the reforms he had agreed to with the IMF, including cutting back the exorbitant business privileges of members of the president’s family. Another was a sudden surge in uncertainty about the president’s political future after he became seriously ill in early December. Investors anxious about the country’s future should Suharto die or be incapacitated off-loaded rupiahs. Then, last week, the government unveiled a budget that was greeted locally and overseas with skepticism and disappointment.

As reports that the IMF bailout might be in jeopardy circulated, panic broke loose in Indonesia. Big investors and middle-class Indonesians alike dumped rupiahs.

The root of the problem was political credibility. Accumulated doubt over the president’s age, health and, above all, his ability to deal effectively with the rampant business cronyism surrounding his regime led to a rapid loss of confidence in his leadership. In seven months, the rupiah had fallen from 2,500 to below 11,000 against the dollar. With the country seemingly on the verge of an economic meltdown, a range of Indonesians across the political spectrum openly--and daringly--called for Suharto to step down.

Internationally, there is genuine worry that Indonesia might be forced to declare a moratorium on debt repayment or, worse, that the country may descend into economic and political chaos. With a population of more than 200 million, Indonesia is the world’s fourth most-populous country and is the pivotal state in Southeast Asia. Instability in Indonesia could rattle Southeast Asia and have far-reaching financial ramifications for the other troubled economies in Asia and, possibly, the global economy. Singaporean, Korean and Japanese banks are all believed to have a heavy stake in Indonesia. There is fear that financial institutions elsewhere in the region might go the way of the once high-flying Hong Kong investment house Peregrine Investments Holdings, Ltd, which collapsed last week as a result of a bad loan to an Indonesian firm.

It is not hard, then, to understand why the United States and the IMF are so eager to get Indonesia back on its feet. In the short term, the barrage of international encouragement and pressure seems to be producing results. President Suharto has announced a truly stunning package of reforms. In addition to containing a number of expected elements--a revised budget, more realistic macroeconomic projections and financial reforms--the package contains a series of measures that radically slash many of the most notoriously crony business arrangements. Among the breathtaking list of items to be canceled immediately are subsidies for the controversial national car project and the national aeroplane industry, the highly profitable flour and sugar monopolies, the cement, paper and plywood cartels, and a cluster of other projects controlled by presidential relatives or cronies.

The significance of this package is that it cuts right to the heart of the patronage network surrounding the presidency. Precisely because there are so many measures that are so costly to him and those immediately around him, it has the potential to reestablish the credibility of Suharto and his government in the eyes of the investment community and Indonesians at home. The reforms deliver more basic change than even the optimistic observers would have thought possible.

For anyone worried about financial stability in Asia and its global implications, this appears to be very good news. But there is a catch. By rushing in as they have, the IMF and the United States have effectively saved Suharto’s political neck. Another few days of the kind of panic that gripped the country a week ago would almost certainly have triggered his downfall.

But having rescued Suharto and obtained the dramatic reform package that currency markets have been craving, the United States and the IMF have become hostage to the Indonesian president’s political fortunes. If Suharto had been swept from office, there would have been great risk, but the chance for a new beginning. With Suharto still in power, there may be a revival of confidence in the short term but, inevitably, longer-run doubt over his ability to see through economic reconstruction will remain. This is unavoidable, given his age, health and the uncertainty associated with succession in such a centralized political system.

The intervention of the United States and the IMF, and the ensuing dramatic policy turnaround announced by Suharto, have purchased breathing space and the possibility of stabilization in Indonesia. But it also carries the risk that the whole rescue effort will unravel if Indonesians and international investors remain unsure about Suharto’s ability to survive. If the rupiah still fails to recover, the situation may be more grave than it would have been without this week’s international intervention.