Indonesia's economy in free-fall
By Eva Cheng
On January 22, banks in Indonesia demanded a massive 16,750 rupiahs for every US dollar they put on offer, but paid only 11,000 rupiahs for each dollar sold to them.
The banks created the 5750 gap between the buying and selling rates to protect themselves against unfavourable movements in the currency. The huge size of the gap indicated that they expected the rupiah could plunge further, very quickly.
The scale and speed of the rupiah's nosedive over the past five months was previously unthinkable. From a 2200 selling rate last August, when President Suharto first called in the International Monetary Fund, to 4500 at the end of December, to 10,000 a week ago, when the IMF signed a second, tougher loan package with Suharto, to 16,750 on January 22. There seems no lower limit.
The sharp drop since the IMF's new package was signed reflects a loss of confidence in the rupiah that extends far beyond the banks.
Especially worried were private non-financial institutions whose liabilities, said the IMF on January 19, must not be guaranteed by the government. In other words, money from the IMF-led package must not be used to save them.
This could mean hell for many Indonesian companies, especially those who contracted sizeable foreign currency loans. These loans are estimated to total US$65 million, or roughly half of Indonesia's official foreign debt of US$120 billion.
Most of these loans were taken out before the crisis, with repayments based on revenues expected in a much more orderly market and on the old exchange rates. Based on the January 22 rate, these companies would need rupiah revenues eight times their pre-crisis levels to service their loans.
Most companies don't have such income. A plunging rupiah makes anything with an imported content much more expensive and things are made worse by the general fall in the markets, most notably listed stocks and property.
These companies' problems can't be easily contained, however. Many, forced to default on their loans, will drag their banks — domestic or foreign — down with them.
Not surprisingly, banks have become reluctant to provide new, even short-term or trade finance. This has ground many businesses to a halt, including some which didn't borrow foreign currencies.
Banks are beginning to pull the plug, generally. When that happens, the problem becomes systemic. That's the phase Indonesia began to slide into late last year, a slide that has accelerated in recent days.
Protecting the banks
In this context, the IMF-led package is self-defeating. Although this is not clearly spelled out, the IMF-led US$40 billion loan will be substantially used to arrest the damage inflicted on the major imperialist banks. This is primarily to avoid them pulling the plug because if they do, many of the otherwise viable Indonesian banks would also be at risk.
Banks borrow from one another routinely for shorter term funds, but that inter-bank market could be seriously disrupted in a crisis. More banks, those whose capital base isn't big enough to weather the recent losses, including from defaulted loans and foreign exchange losses, could go under.
But which companies aren't indebted? Very few in Indonesia. There have been strong incentives to borrow heavily in recent years. Stock prices were shooting up, and a key way not to miss out on speculative profits was through using borrowed funds, the more the better, to buy shares.
As well, competition was undermining profit rates and a major way to compensate for this was by expanding the size of one's business, again by using borrowed funds.
Additionally, inflation was high so it was cheaper to expand through funds borrowed from overseas than by raising capital through local share issues. This impetus was strengthened by the tax deductibility of interest payments on loans.
With the rupiah pegged to the US dollar, and a lower inflation rate in the US, it has been cheaper and safer to borrow in US dollars. And it's been easy to get such loans because there are many keen lenders. Many banks have problems placing their funds profitably, which is why they were prepared to lend even to operations with a precarious capacity to cover their liabilities.
These factors together resulted in a heavily indebted business sector in Indonesia which was vulnerable to a systemic break out when the value of the currency began to drop.
Economic dependence
Added to the external debt is an equally large public sector debt. The interest bill to service the US$120 billion public sector liability in Indonesia — which has more than doubled over the last 10 years — is equivalent to 30-40% of export incomes throughout the last decade.
This burden ensured that Indonesia's current account stayed in deficit, despite continuous surpluses in external trade.
Despite a shift to low-value-added manufacturing, Indonesia still depended heavily on oil, gas and related products for its export income.
The country's key exports are timber, plywood, rubber and coffee. The prices of these commodities, which are by no means stable, determine, to a large extent, Indonesia's ability to meet its external payments.
Of Indonesia's imports, 75% are intermediate goods and 20% are capital goods, all essential for its industries. The high proportion of crucial production components that have to be imported means that the plunging value of the rupiah (and therefore the increasing costs of imports) has hit Indonesia hard.
As well, some staples, such as rice, are also imported. The persistent drought in the country increased the need for such imports and with the dive in the rupiah, import bills and market prices have ballooned, hitting the poor hardest.
The IMF-led rescue package, first sealed in late October, was supposed to restore economic stability. Clearly it didn't. With his January 6 budget (which was based on widely optimistic economic growth forecasts), Suharto defied many of the key conditions stipulated by the IMF if the government is to draw US$3 billion from the credit line each quarter.
The new IMF package, imposed in January when the rupiah plunged to 10,000 to the dollar, provides the same amount but on generally tougher conditions. But even that didn't do the job. The plummeting of the rupiah just days after the new package was signed is a slap in the IMF's face.
The IMF pledged to provide US$10 billion of the $40 billion credit, but the US$23 billion funded by the World Bank, Asian Development Bank and from Indonesia's own reserves must be exhausted before the remaining $30 billion, provided by seven governments, can be used. With such a large stand-by credit line, it was hoped that the vicious downward spiral could be stopped and in particular that the imperialist banks wouldn't pull the plug.
The governments of the home country of those banks with most exposure to Indonesia (Japan, Singapore, the US, Australia, Malaysia, China and Hong Kong) committed to the stand-by loan to save their own banks, and their own economies.
Stricter austerity
Representing the interests of foreign industrial and finance capitalists who want a stronger hold on the Indonesian market, the IMF's first round of prescriptions met with strong resistance. By forcing Indonesia's door further open to foreign exports and investments, the IMF violated the interests of some local capitalists, most notably the Suharto family.
Centred around his six children, the Suharto clan has business interests in banks, telecommunications, toll roads, petrochemicals, power plants, airlines, hotels, orange-trading, car production, and more. The closing down of 16 Indonesian banks by the IMF hit three of them and the proposed suspension of infrastructure projects will hit a few more. Then there are Suharto's mates who have monopolies in many basic commodities. No wonder they protested!
The new IMF package, apart from allowing for a budget deficit of 1% of GDP rather than a 1% surplus as demanded in the original package, imposes tougher conditions, further disadvantaging Indonesian capitalists.
The original package permitted a current account deficit of up to 2% of GDP, but it now has to be a "sizeable surplus". The 12 infrastructural projects originally postponed will now be cancelled immediately. The exclusive tariff privileges granted to Tommy Suharto's Timor car company, which were to be subject to a World Trade Organisation judgement, will now be revoked immediately.
Further, the original package prescribed the immediate dismantling of import and marketing monopolies, as well as price restrictions in three key agricultural commodities. For all other agricultural commodities, these changes were to be phased in over the next three years and exemptions were granted to rice and refined sugar. Now the exemption applies only to rice, the monopolies over the import and distribution of sugar and distribution of wheat flour will be dismantled from February 1, domestic trade in all agricultural products "will be fully deregulated", and "all restrictive marketing arrangements will be abolished" from February 1.
In the original agreement, tariffs were to be reduced, including on some items protected by the Indonesian government, and non-tariff barriers were to be dismantled over the next three years. Now, from February 1, tariffs on all food items will be cut to a maximum of 5% and on non-food agricultural products they will be cut by 5%.
These measures will benefit foreign capitalists. They will not correct the structural weakness of the Indonesian economy. Neither will they guarantee price reductions to benefit the Indonesian poor who have already been squeezed hard by the slide of the rupiah, much higher inflation and job losses.
On the contrary, the new agreement specifies, for example, that energy subsidies be cut and that a rise in fuel and electricity prices be phased in.
While it "assures" Indonesians that these price increases will be "kept to a minimum", the majority of Indonesians rely heavily on kerosene as cooking fuel (and to boil drinking water). Amidst galloping price increases for all essential commodities, further rises in the price of kerosene could be socially explosive.