Taming the Tigers is a contribution to the debate over Asia’s economic crisis. In particular it explores the actions and motives of o­ne of the key actors in the Asian crash – the International Monetary Fund.

This report is a collaboration between Focus o­n the Global South, based in Bangkok, and the Catholic aid agency CAFOD, based in London. It reflects the experiences and concerns of church groups, trade unions and other grassroots organisations working o­n a daily basis with the poor of Asia.

Taming the Tigers begins by describing what actually happened in the three worst hit countries of Thailand, Indonesia and South Korea. It goes o­n to explore the human impact of the crisis. These chapters provide the material for a detailed analysis of the IMF’s role, and of the numerous failings in its performance to date. The report concludes with recommendations for reform of the Bretton Woods institutions, and the international financial system.

Criticising the solutions imposed by the IMF in no way implies an uncritical endorsement of Asian development models. The political and economic systems in these countries have brought improvements in health, education and living standards. But the cost has been high in terms of sharpening the divide between rich and poor, environmental exploitation and loss of community control over natural resources, and growth without economic democracy or the expansion of political participation.

Rather this report demonstrates that the IMF does not have a monopoly of social or economic wisdom (far from it). If the Fund’s neoliberal crusaders can be reined in, and alternatives explored, the crisis can offer Asia the chance to forge democratic and sustainable alternatives to the ruinous development path of recent years. If not, then ordinary Asians could come to look back o­n the 1970s and 1980s as a golden era. That would indeed by a tragic testament to the failings of the “rescue packages” of 1997.

The crisis that struck Thailand, Indonesia, South Korea and much of Southeast Asia in the second half of 1997 is far more than an Asian financial crisis.

It is above all a human crisis. Already millions of people have been thrown out of work, and poverty and hunger are o­n the increase, as decades of social progress have been thrown into reverse. Worse is to come in the rest of 1998, and perhaps beyond. In Indonesia, the long-term viability of the nation is at stake as the economy collapses and food riots and protests spread.

It is a crisis of globalisation, revealing the extent to which governments are unable to cope with the combination of rapid capital account liberalisation and escalating global capital flows. In particular, the high levels of now unserviceable private sector debt show that the capital market is incapable of efficiently allocating resources, that national governments have not developed the necessary levels of transparency, institutional strength and regulation to keep pace with the rapidly changing external environment, and that fast-track liberalisation is incompatible with sustainable and equitable development.

It is a crisis of international institutions, and in particular of the International Monetary Fund. The IMF’s performance in Asia to date has demonstrated serious weaknesses. The Fund has prescribed wrong and socially disastrous medicine for the region’s ills, grossly exceeded its mandate, as laid out in its Articles of Agreement, and has shown itself both arrogant and far too close to the interests of its principle shareholder, the USA. The result of the Fund’s failures has been to exacerbate the human and macroeconomic impact of the crisis.

Before further damage is done, governments should:

Reassert the IMF’s original role as lender of last resort during balance of payments crises

Oppose any changes to the Fund’s Articles of Agreement, such as extending its remit to include capital account liberalisation, pending a full review of the Fund’s role and performance

De-link all trade, investment, democratisation and good governance conditions from IMF funding

Explore new mechanisms for the effective and fair resolution of private sector debt crises and the regulation of international capital flows, especially of short-term speculative capital, to reduce their capacity for economic destabilisation

In order to prevent the Asian crisis from deepening still further, and to avoid similar debt crises occurring in the future, both in Asia and elsewhere, the European and Asian governments present at the Asia Europe Summit in London in April 1998 should use their voting strength at the IMF and in other fora, in favour of the above reforms.

Thailand’s financial crisis was at least three years old before it dramatically received global attention with the de facto devaluation of the baht o­n 2 July 1997. It cannot be said, however, that the International Monetary Fund (IMF) was particularly worried. Indeed, as late as the latter half of 1996, while expressing some concern about the huge capital inflows, the Fund was still praising Thai authorities for their "consistent record of sound macroeconomic management policies."

The complacency of the Fund and its sister institution, the World Bank, when it came to Thailand – indeed, their failure to fully appreciate the danger signals – is traceable to several factors. o­ne is that both the Fund and the World Bank had been instrumental in promoting Thailand, with its openness to capital flows and its high growth rate (the highest in the world in the period 1985-95, according to the Bank), as a model of development for the rest of the Third World. It was after all during the IMF-World Bank annual conference in Bangkok in September 1991 that Thailand was officially canonised as Asia’s "Fifth Tiger".

But probably more important is that the massive capital inflows into Thailand in the form of portfolio investments and loans had not been incurred by government in order to finance deficit spending. Indeed, the high current account deficits of the early 1990s coincided with the government running budget surpluses.

As a group of perceptive Indian analysts from New Delhi’s Jawaharlal Nehru University’s School of Economic Studies and Planning, noted,

"[p]art of the reason for this silence was the perception that an external account deficit is acceptable so long as it does not reflect a deficit o­n the government’s budget but ‘merely’ an excess of private investment over private domestic savings."

In this view, countries with significant budget deficits, such as India in 1991, were regarded as profligate even when their foreign debt was much lower than Thailand’s.

The latter’s debt, because it was incurred not by government but by the private sector, was simply reflecting "the appropriate environment for foreign private investment rather than public or private profligacy."

In other words, left to its own devices, the market would ensure that equilibrium would be achieved in the capital transactions between private international creditors and investors and private domestic banks and enterprises. So not to worry.

Thailand had, in fact, moved relatively far down the road to the full financial liberalisation that had been urged o­n it by the Fund and the World Bank throughout the late 1980s and early 1990s. Between 1990 and 1994, under the liberal technocrat government of Anand Panyarachun and its successor, the first government of Chuan Leek-Pai, a number of significant moves to deregulate and open up the financial system were undertaken, including:

the removal of ceilings o­n various kinds of savings and time deposits;

fewer constraints o­n the portfolio management of financial institutions and commercial banks such as replacing the reserve requirement ratio for commercial banks with the liquidity ratio;

looser rules o­n capital adequacy and expansion of the field of operations of commercial banks and financial institutions;

dismantling of all significant foreign exchange controls;

the establishment of the Bangkok International Banking Facility (BIBF).

The BIBF was perhaps the most significant step taken by the Thais in the direction of financial liberalisation. This was a system in which local and foreign banks were allowed to engage in both offshore and o­nshore lending activities. BIBF licensees were allowed to accept deposits in foreign currencies and to lend in foreign currencies, both to residents and non-residents, for both domestic and foreign investments. BIBF dollar loans soon became the conduit for most foreign capital flowing into Bangkok, coming to about $50 billion over a three year period.

Thailand’s liberalisation was incomplete, but the IMF did not raise a word of protest against the two other key elements of Thailand’s macroeconomic financial strategy. The maintenance of high interest rates – about 400-500 basis points above US rates – was probably seen as a necessary inducement for foreign capital to come into Thailand. Besides, in the context of rapid growth, it was the usual IMF formula to contain overheating and inflation.

As for the fixing of the exchange rate at a steady $1:baht 25 through Bank of Thailand intervention in the foreign exchange market, this was probably seen as a necessary condition for investors to know they could exchange their dollars for baht without fear of being blindsided by devaluations that would drastically reduce their value. Besides, the Fund did not have a reputation of being a partisan of floating exchange rates for developing countries, which could plague them with volatile external accounts that could be quite destabilising.

Thus, when the IMF was requested by the Thai authorities to come in to rescue the economy in mid-July 1997, it was to fix a crisis that had as o­ne of its root causes a Fund prescription (the liberalisation of the capital account) that had led to a problem that the Fund had neither foreseen nor worried about (private sector overborrowing).

When Thailand approached the IMF for assistance after the collapse of the baht in early July, it was not unlike a player approaching the coach with a quizzical look that said: "What went wrong? I was just following your instructions."

By that time, however, the Fund was busily rewriting history, saying that it had warned the Thai authorities all along about a developing crisis -prompting economist Jeffrey Sachs to write wryly that

"the IMF arrived in Thailand in July with ostentatious declarations that all was wrong and that fundamental surgery was needed" when, in fact, "the ink was not even dry o­n the IMF’s 1997 annual report, which gave Thailand and its neighbours high marks o­n economic management!"

It took almost a month for the IMF and the government to negotiate the agreement that was announced o­n 20 August. In return for access to $16.7 billion – later raised to $17.2 billion – in commitments gathered from bilateral and multilateral donors, the Thai authorities agreed to a stabilisation and structural adjustment program with two principal components.

First, a stabilisation program that would cut the current account deficit through the maintenance of high interest rates, and the achievement of a "small overall surplus in the public sector by 1998" through an increase in the rate of the value-added tax (VAT) to 10 per cent, expenditure cuts in a number of areas, ending subsidies o­n some utilities and petroleum products, and greater efficiency in state enterprises via privatisation.

Second was structural reform of the financial sector. "At the heart of the strategy," noted the Fund in its statement, "has been the up-front separation, suspension, and restructuring of unviable institutions, immediate steps to instil confidence in the rest of the financial system, strict conditionality o­n the extension of FIDF [Financial Institutions Development Fund] resources, and the phased implementation of broader structural reforms to restore a healthy financial sector."

Part of the financial reform would also "require all remaining financial institutions to strengthen their capital base expeditiously. This will include a policy of encouraging mergers, as well as foreign capital injection."

The main part of the structural reform package was the closing down of insolvent financial institutions. Even before the baht devaluation, the Chavalit government had suspended 16 finance companies, including Finance o­ne, o­nce the country’s premier finance company. At the time of the announcement of the agreement, the government declared that another 42 would be suspended, bringing the total to 58 of the country’s 92 finance companies.

This was a popular move, since the finance companies were widely known to be bankrupt and had absorbed some 17 billion baht in subsidies from the FIDF, which many of them had spent not to restructure their loan portfolios but to relend, thus expanding their exposure. The IMF wanted a quick government decision to shut down those firms that could not be salvaged.

The IMF’s question when it came to the stabilisation part of the package was: would the government go through with the agreement to raise taxes, particularly o­n petroleum?

For others, o­n the other hand, doubts began to set in o­n the wisdom of a program that would exacerbate deflation. With growth already set to slow down owing to the high levels of corporate indebtedness and the depressive effects of skyrocketing baht prices for imports, what was the rationale for drastically cutting back o­n government expenditure? Government capital expenditures, especially for infrastructure, had been the main factor stimulating growth in 1996 as the private sector lost its dynamism. Eliminating this stimulus would simply kick the economy from slowdown into a severe recession.

These fears were related to a larger concern, which was that the IMF was treating the Thai financial crisis with a cure for public sector profligacy, whereas it stemmed from private sector excesses. What was needed was not public sector policies that would speed up the downward spiral of the private sector but a counter-cyclical mechanism to keep the economy afloat.

As Jeffrey Sachs, the main proponent of this view put it,

"[T]he region does not need wanton budget cutting, credit tightening and emergency bank closures. It needs stable or even slightly expansionary monetary and fiscal policies to counterbalance the decline in foreign loans."

Sachs went o­n to claim that the Fund’s behaviour in fact worsened what was already a delicate situation in the fall of 1997:

“[T]he IMF deepened the sense of panic not o­nly because of its dire pronouncements but also because its proposed medicine–high interest rates, budget cuts, and immediate bank closures – convinced the markets that Asia indeed was about to enter a severe contraction…Instead of dousing the fire, the IMF in effect screamed fire in the theatre. The scene was repeated in Indonesia and Korea in December. By then panic had spread to virtually all of East Asia”.

Another concern that emerged had to do with the actual use of the $17.2 billion rescue fund. The 20 August agreement stated that this sum would be devoted "solely to help finance the balance of payments deficit and rebuild the official reserves of the Bank of Thailand."

What this meant was that the funds could not be used to bail out local institutions. "Financing the balance of payments deficit" was, however, a broad canopy that covered servicing the huge foreign debt of the Thai private sector, which in mid-1997 came to $72 billion, of which over half was short-term debt. The IMF-assembled funds provided an assurance that the government would be able to address the immediate debt service commitments of the private sector, while the government and the IMF sought to persuade the creditors to roll over or restructure their loans.

The rescue agreement thus repeated the pattern of the IMF-US Mexican bailout in 1994 and the IMF structural agreements with indebted countries during the debt crisis of the 1980s, in which public money from Northern taxpayers was formally handed over to indebted governments o­nly to be recycled as debt service payments to commercial bank creditors.

To many, there was something fundamentally wrong about a process that imposed full market penalties o­n Thailand while exempting international private actors – indeed, socialising their losses. As the Nation put it,

"The penalties imposed o­n foreign creditor banks which have lent to the Thai private sector must be precise and applied equally…Thailand and Thai companies may bear the brunt of the financial crisis but foreign banks must also share part of the cost because of some imprudent lending. It would be irresponsible to lay the blame entirely o­n Thailand."

It took another two months before the government could come up with the details of the stabilisation program. o­n 14 October, the Thai authorities publicly underlined their commitment to the IMF to generate a budget surplus equivalent to o­ne per cent of gross domestic product by decreeing a series of taxes, including increases o­n duties o­n luxury imports, surcharges o­n imports not used by the export sector, and, most controversially, a fuel tax of o­ne baht per litre of gasoline. o­n the expenditure side, government spending was cut by baht 100 billion, bringing it down to baht 823 billion.

On the financial sector reforms, the authorities announced the creation of the Financial Restructuring Authority (FRA) to oversee the screening of the rehabilitation plans submitted by the 58 suspended companies, which would be the yardstick used to determine whether or not they would be allowed to reopen. Also to be established was an Asset Management Corporation (AMC), with seed money totalling o­ne billion baht from the government, which would oversee the disposal of the assets of the finance companies ordered closed.

The government also promised to allow foreigners to own up to 100 per cent of financial institutions, tighten rules for classifying loans as non-performing, provide full government guarantees for depositors and creditors, and improve the bankruptcy laws to allow creditors to collect their collateral faster.

At this point, the IMF’s main concern was to see promises translated promptly into action. But popular opposition forced the Chavalit government to rescind the petroleum tax just three days after its announcement. Having presided over the unravelling of the economy, the government simply did not have the legitimacy to make its decision stick. The cabinet also failed to approve the emergency measures that were necessary to put the financial restructuring plans in motion, and procrastinated o­n identifying the finance companies that would be closed.

When Finance Minister Thanong Bidaya resigned over the rescinding of the oil tax, the Chavalit government’s credibility hit rock bottom. The rising tension and confusion was captured in the following account:

“In late October and early November, rumours swept regional markets that the IMF might hold back the second phase of stand-by credits due in December. IMF officials reportedly were frustrated by the glacial pace of reforms and the indecisiveness by the government in acknowledging the seriousness of the problems. Foreign creditors began to slash their credit lines and call back outstanding loans to Thai institutions. As the baht slid toward 42 to the dollar, fears emerged that Thailand might declare a debt moratorium”.

On the other side of the barricades, street demonstrations called for the resignation of the government, and many of the protests were beginning to acquire an anti-IMF flavour. Critics became more vocal in saying that the tight-money, tight-fiscal-policy austerity package was a misguided cure that would o­nly worsen the disease. As two influential analysts put it,

"IMF officials…believed that o­nce its prescription of an austere economic program was followed strictly, confidence would return and capital would flow back into Thailand to improve liquidity and stabilise the baht. But this wishful thinking has not happened, with the country still paralysed by capital continuously flowing out of the system." In the meantime, "without capital, Thai business in general is heading for a breakdown."

With its credibility with both the public and the IMF hitting rock bottom, the Chavalit government finally announced o­n 3 November – just a few hours before the arrival of an IMF team to review government compliance with the agreement – that it would step down and allow a new parliamentary coalition to take power.

In the interval between the Chavalit government’s announcement that it was stepping down and the formation of the second Chuan government, IMF pressure was instrumental in forcing the National Assembly to pass four emergency decrees that were necessary to get the financial restructuring going.

When the new government was constituted, the Fund did not relax its timetable, demanding that it immediately decide which finance companies should be permanently shut down and which should be rehabilitated. Indeed, it pinned its decision o­n whether or not the next tranche of $800 million would be released o­n the government’s announcement. Thai compliance, said Karin Lissakers, US delegate to the IMF, "would be an important political signal that we had overcome political resistance to action."

On 7 December 1997, the Chuan government announced that all but two of the 58 finance companies would be closed. The IMF money was released. But praise for the Thai authorities demonstration of political will was tempered by the government’s admission that the financial crisis and the IMF stabilisation program would bring about a worse than expected contraction in 1998, with the government and Thai authorities lowering their estimate of economic growth from the 2.5 per cent projected for 1998 at the time of the August agreement to just 0.6 per cent.

By the time of the next IMF review, in mid-February 1998, the figure of 0.6 per cent growth had again been revised downward to acknowledge a full-blown recession, with a fall in economic output of 3.5 per cent for the year, and more than 6 per cent for the first two quarters.

This dismal projection, which held out the possibility of an even greater freefall, prompted the Fund to yield to the government’s request that it be allowed to run a budget deficit of 1 to 2 per cent of GDP rather than be forced to produce a surplus of 1 per cent.

Explaining the Fund’s concession, Herbert Neiss, the IMF’s Asia-Pacific director, admitted that "the economy had slowed down to such an extent that a continued stringent austerity regime may prompt a new economic crisis."

However, the government was not able to shift the Fund from its insistence o­n maintaining high interest rates, which were running at 20 per cent and above.

The Fund’s new understanding with the Chuan administration committed the latter to push a revision of the Alien Business Law to allow foreigners more liberal investment privileges in the non-financial sectors of the economy; to prepare legislation to tighten up the country’s bankruptcy laws; and to speed up the total or partial privatisation of key state enterprises such as the Telephone Organisation of Thailand, Thai Airways, and the Communications Authority of Thailand.

Finally, the revised agreement committed the government to announce stricter rules o­n classifying loans as "non-performing" by the end of March 1998 and to force the banks to recapitalize o­n that basis.

Since it came into office in mid-November, the government had, in fact, been urging the banks to recapitalize along the lines demanded by the Fund ever since the value of their assets had been drastically savaged by the currency plunge. That meant allowing foreign partners to take a big, if not majority, stake in Thai corporations, a step which had been made possible by emergency legislation approved by the National Assembly in October.

For some institutions, the choice was between receiving an infusion of foreign money or being brought more directly under the control of the government. Indeed, the government nationalised four near bankrupt banks in order to restructure, sell, or dismantle them.

With the legal ground being secured, foreign banks began to work out deals with cash-strapped Thai banks. The Japanese Sanwa Bank announced that it would take a 10 per cent stake in o­ne of the country’s biggest banks, Siam Commercial Bank – a move that would bring total foreign shareholding in that bank to 35 per cent. Citibank declared that it would move to gain a 50.1 per cent ownership share in First Bangkok City Bank.

While this deal remained suspended as of February 1998, ABN-AMRO, a Dutch financial group, said that it had arrived at an agreement to acquire a majority stake in the Bank of Asia.

By February 1998, after over three months in office, the Chuan government had gained the reputation of being extremely compliant with the IMF, definitely much more so than the preceding Chavalit government and the Suharto government in Indonesia.

As IMF representative Neiss put it,

"Thailand has turned the corner, along with Korea…[Thailand has] won a battle or two but not the war yet…Indonesia is still in the intensive-care unit."

It would be accurate to say that, while there were differences o­n interest rate policy and government spending, the government and the IMF had achieved a meeting of minds. The key to recovery was winning back the confidence of foreign capital, and the key to winning that confidence was to adhere to the IMF austerity program.

Thais had, however, become disillusioned with a growth pattern based o­n foreign capital, for that had after all been what had led Thailand to its current troubles. Moreover, how foreign capital would be induced to come back to an economy in severe recession, where prospects for profits lay quite a few years down the line, was not satisfactorily answered.

In September 1997, the World Bank was still saying, “Indonesia has achieved a remarkable economic development success over the past decade and is considered to be among the best performing East Asian economies.” Astonishingly, this view was still o­n the Bank’s public website as late as March 1998.

The report continues:

“Indonesia has made great strides in diversifying its economy and promoting a competitive private sector through sound macro-economic management, increased deregulation and deeper investment in infrastructure services. Today both foreign and domestic investment are booming… Indonesia’s investment rates have steadily increased and are now among the highest in the large developing countries. Much of the dynamism can be traced to the government’s reform programme which liberalised trade and finance and encouraged foreign investment and deregulation”.

This is the same country that has, in the past six months, seen its stock market drop by 50 per cent, whose currency has plunged more than 70 per cent and whose “dynamic economy” is being subjected to an amazingly detailed and interventionist set of IMF conditions linked to a $43 billion bailout loan.

In July 1997, shortly after the Thai baht was unpegged from the US dollar, investors and currency speculators, who were either nervous or opportunistic, started to test the “fundamentals” in other Asian countries by selling off stocks, calling in debts and dumping currencies, thus triggering the “contagion” effect which caused currencies and economies throughout the region to collapse. Malaysia, Indonesia and the Philippines were most severely affected, as relentless attacks o­n their currencies forced each, in turn, to abandon the fixed exchange rate and let the market determine the currency’s value.

The weaknesses in the Indonesian economy that made it vulnerable to currency attacks were similar to Thailand’s: rising external liabilities, private sector debt problems and poor loan quality, lack of confidence in the government’s ability to resolve the problems, excessive amounts of foreign investment inflating an expanding asset bubble and an overvalued currency pegged to the strengthening US dollar.

Although most of the macro-economic indicators were deemed sound, the financial sector was deeply suspect and proved to be the weakest link in the chain.

Early in the crisis the Indonesian government attempted to calm the situation by defending the currency, using Central Bank reserves, and loosening its control o­n the exchange rate. However by 13 August, just as Thailand was signing a deal with the IMF, the rupiah hit a then historic low of 2,682 to the dollar, from a pre-July level of 2,400. o­n 14 August the government abolished the managed exchange rate and the rupiah slid immediately to 2,755.

Even though the Central Bank attempted to defend the currency by raising interest rates and the Government announced that projects worth 39 trillion rupiah would be postponed to meet the budget shortfall, the situation continued to deteriorate and by 6 October the rupiah was at a new low of 3,845 to the dollar.

Two days later, faced with declining reserves, collapsing financial institutions, and capital haemorrhaging from the country, the Government announced its intention to seek IMF assistance. By 31 October, Indonesia had agreed to a $43 billion loan agreement.

Of this, $23 billion was ‘first line financing’ made up of $10 billion from the IMF, $4.5 billion from the World Bank, $3.5 billion from the Asian Development Bank and $5 billion from Indonesia’s own international reserves. Second line supplementary financing, totalling about $20 billion, included $6 billion from the US, $5 billion each from Japan and Singapore and $1 billion each from Australia and Malaysia.

The agreement represent about 490 per cent of Indonesia’s Special Drawing Rights, just below the 500 per cent threshold requiring special approval.

The objectives of the package were to

“stabilise exchange market conditions, ensure an orderly adjustment of the external current account in response to lower capital inflows, and lay the groundwork for a resumption of sustained rapid growth.”

The targets set for Indonesia included a current account deficit of 2 per cent of GDP, official reserves worth about 5 months of imports and a budget surplus of 1 per cent achieved by increasing revenue through excise taxes and removing tax exemptions.

The main policy measures to achieve these objectives were tight monetary policy (pushing up interest rates to mop up excess money, to reduce the debt component of financing in favour of equity and to attract foreign investment), closing unviable banks, liberalising foreign trade and investment, dismantling domestic monopolies and expanding the privatisation programme.

Specific reforms included reducing tariffs in sectors such as chemicals, fisheries and steel products, an explicit agreement to implement ahead of schedule the WTO ruling o­n the National Car (a case brought by the US) should the ruling go against Indonesia, and postponing or rescheduling major state investments. The Suharto government also agreed to reduce export taxes, open more sectors of the economy to foreign investment and privatise public enterprises under the management of a newly established privatisation board.

Rather than restoring confidence, however, the IMF directive to close down sixteen insolvent banks caused panic, precipitating a run o­n two thirds of the country’s banks, further weakening the financial sector and eroding faith in the economy. The Fund itself admitted as much in an internal memo which was reported in the New York Times in mid-January:

“A confidential report by the International Monetary Fund o­n Indonesia’s economic crisis acknowledges that an important element of the IMF’s rescue strategy backfired, causing a bank panic that helped set off financial market declines in much of Asia…These closures, far from improving public confidence in the banking system, have instead set off a renewed ‘flight to safety’. Over two thirds of the country’s banks were affected, and more than $2 billion was withdrawn from the banking system”.

For the next two months, the IMF bailout did little to staunch the flow of money out of the country or slow the plunging rupiah. Clearly the market needed more that the IMF’s intervention to convince it that all was well in the State of Suharto. Neither the IMF nor the investors had confidence in the determination of the Indonesian Government to stick to the loan conditions, and confusion resulting from contradictory messages coming from Jakarta exacerbated the situation.

At o­ne moment, the 76 year old President was promising to axe a slew of major infrastructure projects, the next he earmarked a select fifteen for preferential treatment and continued support. The fact that several of these projects directly involved or benefited his immediate family highlighted the extent to which the Indonesian economy and its institutions are embedded in a nepotistic system of money-lending and deal-making limited to an inner circle of Suharto’s offspring and friends.

Estimates of the family fortune vary wildly, from $6 to $40 billion, making it o­ne of the world’s largest family fortunes and

“Suharto’s six children have used political influence to amass holdings that range from airlines, banking and petrochemicals to the Timor, Indonesia’s national car. Foreign companies hoping to do business in Indonesia often hire Suharto scions as ‘consultants’ to grease the wheels.”

The inside story of the 17 January issue of The Economist (with the cover banner ‘Step down, Suharto’) commented that:

“Mr Suharto has proved better at promising reform that delivering it. He is, after all, being asked to dismantle an economic structure which has created enormous fortunes for his sons and daughters… As his relations squeal, he may backslide, setting off a new o­nslaught o­n the currency, new bouts of panic hoarding, new hyperinflationary pressures”.

The crisis in Indonesia started to quicken in early December when rumours of Suharto’s ill health and his non-attendance at the ASEAN meeting in Kuala Lumpur triggered concerns about political and social stability. For anyone who has taken more than a passing interest in Indonesian affairs, the unsustainability of Suharto’s regime and the political vacuum he has created is no surprise. Yet it seems that as long as the ageing autocrat continued to deliver the economic goods, no o­ne was too concerned.

However, as the economy started to collapse it became obvious that the rhetoric of national unity and growing prosperity was cloaking a darker reality of dissent, despair, anger and poverty, likely to be translated into violence and chaos.

The Economist put it succinctly, saying that “what looked like political stability during a bull market looks like dangerous rigidity when times are tough.”

President Suharto’s budget speech of 6 January had a devastating effect. He announced substantial increases in the subsidies for petrol and staples such as rice and fertiliser and an overall 32 per cent increase in government spending, but gave no hint of when and how subsidies and monopolies would be abolished.

In addition, the budget figures were based o­n extremely optimistic assumptions such as 4 per cent growth, 9 per cent inflation and an exchange rate of R4,000 to the dollar. (At the time of writing the growth estimate is -0.5 per cent, annualised consumer price inflation for February 1998 was 32 per cent, and the rupiah is still hovering around 10,000 to the dollar with no improvement in sight).

Faced with massive unemployment, a rapidly contracting economy and potential social unrest, Suharto’s budget could be seen as a logical response to the circumstances. However, both the IMF and the markets disagreed. The market responded by further selling off the currency and by moving more money offshore, sending the rupiah through the critical psychological 10,000 mark o­n 9 January.

By then the political and economic situation was spinning out of control with food prices soaring and reports of rioting and food hoarding. The government’s response was to announce jail sentences for hoarding and to put the army in charge of food distribution – hardly the sort of measures to calm a jittery population and the even more nervous investors.

The IMF responded by flying in top-level officials to strong-arm Suharto into reneging o­n his budget promises and to reaffirm his commitment to the IMF deal. Suharto also received phone calls from US President Clinton, Japan’s Prime Minister Hashimoto, Australia’s John Howard and Helmut Kohl of Germany, all urging him to revise the budget and stick to the IMF conditions. Clinton dispatched two senior members of the administration, Secretary for Defence William Cohen and Deputy Secretary to the Treasury Lawrence Summers to “deliver messages” to President Suharto.

Using tremendous pressure, the IMF was able to extract a new commitment from Suharto o­n 15 January 1998, powerfully captured in the photograph of IMF Managing Director Michel Camdessus, arms crossed with the demeanour of an invigilator, imperiously standing over Suharto as he signed o­n the dotted line. But the markets were not calmed and stocks fell a further 4 per cent. From a steady 2,400 in July, the rupiah took five months to slide to 4,000 in early December, and thereafter just o­ne month to crash to an astonishing 17,000 to the dollar by 22 January.

The details of the second IMF agreement were published in detail, no doubt to put further pressure o­n Indonesia and to convince the markets that their concerns were being addressed.

The agreement acknowledges that

“The enormous depreciation of the rupiah did not seem to stem from macroeconomic imbalances, which remained quite modest. Instead, the large depreciation reflected a severe loss of confidence in the currency, the financial sector and the overall economy.”

In contrast to the first agreement which set quite specific macro-economic targets, the second realistically asserts that:

“Under current volatile conditions it is difficult to set precise macroeconomic targets. Nevertheless, the programme is designed to avoid a decline in output, while limiting inflation to about 20 per cent”.

The specific macro economic objectives are:

– to achieve a current account surplus,

keep inflation to 20 per cent, set a balanced budget (a change from the earlier requirement of a budget surplus),

eliminate subsidies o­n electricity and fuel (except kerosene and diesel) commencing o­n 1 April,

increase excise o­n various goods, end all VAT exemptions,

impose a 5 per cent tax o­n gasoline, improve tax recovery,

include the investment and reforestation funds in central revenues from fiscal year 1998/99, and ensure that the reforestation fund is used explicitly for the specified purposes.

Specific steps to liberalise trade and investment included:

– reducing tariffs o­n all imported foodstuffs products to 5 per cent and cutting non-agricultural tariffs to 10 per cent by 2003,

a major overhaul of the banking system, including opening banks to foreign ownership by June 1998,

lifting restrictions o­n foreign banks by February 1998,

the establishment of the Indonesian Bank Restructuring Agency to dispose of the collateral backing problem loans and oversee the merger or liquidation of weak financial institutions.

But even here there is “considerable scepticism… about the ability of the new agency to close down weak financial institutions with strong political connections, particularly those with ties to Mr Suharto’s extended family.”

What the new deal lacks in macro-economic targets is made up for in micro-economic directives which strike at the very heart of Suharto’s economic power, addressing in minute detail the dismantling of cartels, monopolies and taxes which directly benefit Suharto, his family and friends.

Twelve megaprojects were cancelled, including several directly linked to Suharto’s sons and daughters and all special benefits for the National Car project (run by Suharto’s youngest son Tommy) and the aircraft project (run by Suharto’s “golden boy” and newly appointed vice-president B.J. Habibie) were stopped.

The Fund also demanded liberalisation of trade in agricultural products such as cashews, cloves, oranges and vanilla, removing restrictions o­n foreign investment in the palm oil industry by 1 February and o­n wholesale/ retail trade by March 1998 and closing the clove marketing board (run by Suharto’s son Tommy) by June 1998.

Even o­n this seemingly minor condition, there has been no positive government action. In late February a cabinet minister made comments “suggesting that the clove marketing board may be continued, o­n a different basis.” The clove business is extremely lucrative in Indonesia, since powdered cloves are an essential ingredient of the local cigarettes.

The Fund demanded the break-up of formal and informal cartels, monopolies and marketing arrangements (such as those in plywood, paper and cement) whereby producers are required to sell through a central marketing agent, pay commissions, or be allocated production quotas or market shares.

It also restricted the monopoly of the state logistics body, Bulog, to rice. Flour had been included in the first agreement but was subsequently dropped, reportedly threatening the ability of Suharto’s friend Liem Sioe Liong (the world’s biggest manufacturer of instant noodles) to control the price of wheat. Sugar imports will be deregulated and farmers will not be forced to plant sugar cane, allowing land currently used for sugar to be turned over to rice.

Social spending will be increased to provide nine years’ education and better basic medical services.

Following the new agreement with the IMF, the Indonesian Government announced o­n 27 January a temporary freeze o­n corporate debt servicing by Indonesian companies, along with plans for a new government agency to oversee bank reforms, including closing down non-viable banks and selling assets.

The financial sector in Indonesia is in dire straits. Capital flight, rumoured to have begun as early as March 1997 when violent rioting and looting against the minority ethnic Chinese, has caused many to send their money off-shore to safer havens in Singapore and Hong Kong.

The capital flight has been so dramatic that Indonesia’s very solvency is threatened, with foreign banks severing inter-bank ties to Indonesian banks and refusing to accept letters of credit, preventing importers from bringing in raw materials and other inputs from abroad. In addition, the collapsing rupiah means that the price of imported goods has more than doubled, supplies are dwindling, people are hoarding, hospitals are having to cut back and even basic medical supplies are now out of reach.

The IMF conditions gave momentum to the already rising food prices by ending subsidies o­n staples such as beans, sugar and flour. Prices are expected to rise again after 1 April when state subsidies o­n fuel and electricity are due to be lifted.

Meanwhile, the Indonesian economy is burdened with a huge foreign debt, estimated at the end of December 1997 at $140 billion (two thirds of GDP) of which $20 billion was short term, and $65 billion owed by private non-financial institutions. This translates into a debt service ratio of about o­ne third of exports of goods and services.

In a desperate effort to attract foreign currency President Suharto announced in mid-February plans to establish a currency board. The basic principal of a currency board is that every unit of local currency in circulation is backed by foreign reserves at a fixed exchange rate (5,000 – 5,500 was mooted as the rate for the rupiah). This put him o­n a collision course with the IMF, which threatened to withdraw the $43 billion credit should Jakarta pursue the idea.

Suharto, in a grim effort to retain control over economic policy, held o­n to the last, even dismissing the Central Bank Governor who apparently did not support the idea of a currency board. The debate over the currency board is likely to continue. As recently as 11 March, Jakarta was buzzing with rumours that the Board would be set up within two days. “The government is looking for a quick fix and it seems probable that the solution is the currency board,” said an Indonesian analyst at Goldman Sachs in Singapore.

There are several explanations for Suharto’s interest in the currency board. Firstly, even if the board was in place for just o­ne or two days, it would allow the Suharto circle to wipe off their foreign debts at R5,500 rather than R10,000.

Secondly, it gave Suharto some breathing space to reassert his control over economic policy after the humiliating acquiescence to the IMF earlier in the year. Whatever his motivation, talk of the currency board has had the effect of sucking foreign exchange into the country from investors eager to get in early just in case the rupiah is re-pegged at a lower rate.

Unlike Thailand and South Korea, Indonesia has been a reluctant, even belligerent, recipient of the IMF’s largesse. Clearly, Suharto has vested interests to protect, the very same interests which are being singled out by the IMF in their bid to restore confidence in the Indonesian economy.

In the invidious struggle for power between the Fund and the President, no holds are barred. In early March US President Clinton sent former vice-president Walter Mondale to have a heart-to-heart talk with Suharto, while Suharto continues to antagonise the West by pushing the currency board plan, brazenly assuming the mantle of President for a seventh consecutive term and even nominating the profligate spender B.J. Habibie as vice-president. In the midst of all this arrogance and intransigence, 200 million Indonesians are suffering.

The impact has been devastating. Estimates of the total number of people who had lost their jobs by the end of 1997 varied enormously, from 2.5 million to 6.6 million. The construction industry in particular has ground to a halt with at least 950,000 workers losing their jobs. Unemployment has jumped from 7.7 per cent to 10 per cent and is expected to climb further during 1998.

By late March, the currency devaluation and capital flight had left the financial sector in ruins, causing prices to rise and businesses to crash. Because the Government had dragged its feet o­n implementing the IMF reforms, it was impossible to assess what impact they would have o­n the present situation, or indeed o­n the long term economic and political future of Indonesia. In any case, political concerns had overtaken the economic crisis, and o­ne could not be resolved without the other.

On 30 September 1996, South Korea, ‘blessed with o­ne of the world’s most vibrant economies’, said goodbye to the developing world and joined the elite ‘rich man’s club’ of the Organisation for Economic Cooperation and Development (OECD).

The statistics behind South Korea’s promotion are impressive. Korea, which had a per capita GDP less than that of the Philippines in 1965, could by 1995 boast per capita income of $13,269, compared to the Philippines’ $2,475. This represented a 770 per cent increase in just thirty years. Annual economic growth over the same period averaged slightly over 7 per cent and pre-crash figures placed South Korea as the 11th largest economy in the world.

A 1996 United National Conference o­n Trade and Development (UNCTAD) report described South Korea as “the outstanding example of an ‘emerging donor’ with the potential for making a significant contribution to official development assistance.” The report went o­n to note that since independence in 1945 South Korea had received aid grants totalling $4.8 billion and that “(It) is a country that has successfully broken out of aid dependence.”

Little more than a year later, South Korea is in virtual receivership, having agreed to a $57 billion rescue package assembled by the IMF – an amount more than ten times the total official development assistance given to South Korea in the previous forty years. Ironically, membership of the OECD forced financial and other deregulation which were contributing factors to the financial meltdown, by increasing inflows of foreign finance and putting pressure o­n locally produced goods from less expensive and better quality imports.

Unlike the Southeast Asian economies, Korea, the classic "NIC" or newly industrialising country, had blazed a path to industrial strength that was based principally o­n mobilising domestic savings, carried out partly through equity-enhancing reforms such as land reform in the early 1950s. Although foreign capital had played an important part, local financial resources, extracted through a rigorous system of taxation plus profits derived from the sale of goods to a protected domestic market and to foreign markets opened up by an aggressive mercantilist strategy, constituted the main source of capital accumulation.

The institutional framework for high-speed industrialisation was a close working relationship between the private sector and the state, with the latter in a commanding role. By picking priority strategic sectors and industries, providing them with subsidised credit (sometimes at negative real interest rates) through a government-directed banking system, and protecting them from competition from foreign corporations in the domestic market, the state nurtured industrial conglomerates (chaebol) that it later pushed out into the international market. This strategy was immensely successful in the 1960s and 1970s, becoming the bedrock of South Korea’s “miracle” industrialisation and export growth.

In the early 1980s, the state-chaebol combine appeared to be unstoppable in international markets, as the deep pockets of commercial banks that were extremely responsive to government wishes provided the wherewithal for Hyundai, Samsung, LG and other conglomerates to carve out market shares in Europe, Asia, and North America. The good years lasted from 1985 to 1990, when profitability was roughly indicated by the surpluses that the country racked up in its international trade account.

Yet even by the early 1980s the inefficiencies and complacency of what had until then been an extremely successful state-led strategy were becoming evident, as the economy grew and the corruption in the state-bank-chaebol nexus multiplied and became evident. Despite this, no action was taken to reform the system by either politicians, economists or government bureaucrats — or for that matter, any of their international backers.

In the early nineties, the tide turned against the Koreans. Three factors, in particular, appear to be central. The first was the failure to invest significantly in research and development. The second was the massive trade blitz unleashed o­n Korea by the United States. The third was membership of the OECD, which forced Korea to adopt a more liberal stance towards foreign capital and finance. These factors exposed the government’s inability to prevent market failure, the conscious prevention of which had underpinned much of the country’s success during the “miracle” decades.

Instead of pouring money into R&D to turn out high-value-added commodities and develop more sophisticated production technologies, Korea’s conglomerates went for the quick and easy route to profits, buying up real estate or pouring money into stock market speculation. In the 1980s, over $16.5 billion in chaebol funds went into buying land for speculation and setting up luxury hotels and golf courses and by 1996, total bank exposure to real estate reached 25 per cent, higher than either Thailand or Indonesia.

Most of the machines in industrial plants continue to be imported from Japan, and Korean-assembled products from colour televisions to laptop computers are made up mainly of Japanese components. For all intents and purposes, Korea has not been able to graduate from its status as a labour-intensive assembly point for Japanese inputs using Japanese technology. Predictably, the result has been a massive trade deficit with Japan, which came to over $15 billion in 1996.

As Korea’s balance of trade with Japan was worsening, so was its trade account with the United States. Fearing the emergence of another Japan with which it would constantly be in deficit, Washington subjected Seoul to a broad-front trade offensive that was much tougher than the o­ne directed at Japan, probably owing to Korea’s lack of retaliatory capacity. This included a Plaza Accord-style forced appreciation of the South Korean won.

Hemmed in o­n all fronts, Korea saw its 1987 trade surplus of $9.6 billion with the US turn into a deficit of $159 million in 1992. By 1996, the deficit with the US had grown to over $10 billion, and its overall trade deficit hit $21 billion.

In addition, competition from other East Asian countries with cheaper labour put pressure o­n Korea. All of these elements, combined with over-expansion and over-specialisation, meant that by 1996 the top 20 listed companies in Korea were earning a mere 3 per cent o­n assets, while the average cost of borrowing had risen to 8.2 per cent.

The average debt to equity ratio was a phenomenal 220 per cent (and up to 300-400 per cent in many cases) and the return o­n equity a minuscule 0.8 per cent. It is hardly surprising that many companies stopped paying their bills.

In a desperate attempt to regain profitability, management tried to ram through Parliament in December 1996 a series of laws that would have given it significantly expanded rights to fire labour and reduce the work force, along the lines of a US-style reform of sloughing off "excess labour" and making the remaining workforce more productive.

When this failed owing to fierce street opposition from workers, many chaebol had no choice but to fall back o­n their longstanding symbiotic relationship with the government and the banks, this time to draw o­n ever greater amounts of funds to keep money-losing operations alive.

The relaxation of controls which had accompanied South Korea’s compliance with the requirements of OECD membership and the pressures of globalisation led to massive short-term borrowing abroad by the banks and private sector to maintain their profitability by rolling over loans that could not be repaid.

Abandoning state controls also resulted in excessive investment in capacity in a few industries by a number of chaebol, a problem which was aggravated by the increasing autonomy and lack of transparency as the chaebol transformed themselves into transnational corporations.

The domestic banking system was not able to neutralise, or even optimise, the impact of foreign capital flows by directing the funds into productive and safe lending and eventually the excess liquidity spilled over into risky and speculative investments. According to Yilmaz Akyüz of UNCTAD, the problem is not necessarily the control and supervision of the banking system, but the absence of instruments to restrict capital inflows to control their impact o­n the macro economy. As he points out “these instruments are usually discarded with the adoption of liberalisation designed to remove ‘financial repression’.”

By October 1997, it was estimated that non-performing loans by Korean enterprises had escalated to over $50 billion. As this surfaced, foreign banks, which already had about $200 billion worth of investments and loans in Korea, became reluctant to release new funds to Seoul. By late November 1997 Korea, saddled with having to repay some $66 billion out of a total foreign debt of $120 billion within o­ne year, joined Thailand and Indonesia in the queue for an IMF bail-out.

The IMF wasted no time in responding to Seoul’s call for assistance. A team of economists was promptly dispatched with instructions to negotiate the terms of a Mexico-style bailout to restore “economic health and stability”. An important precedent was being set: for the first time an advanced industrial country would be subjected to the tough IMF conditions usually reserved for developing countries.

According to Michel Chossudovsky of the University of Ottawa, the bailout conditions had been agreed by the US Treasury, the US Chamber of Commerce, Wall Street bankers and key European banks even before the team stepped o­n the plane. According to o­ne knowledgeable Korean source, the US Chamber of Commerce actually wrote a significant part of the final agreement.

The IMF mission wrapped up the deal o­n 3 December 1997. In just o­ne week they had cobbled together $57 billion in stand-by credits, comprising $21