Bank Indonesia and the Crisis: An Insider's View

1. Introduction

Introduction 13© 2005 Institute of Southeast Asian Studies, Singapore 1 Introduction The idea of writing an assessment and analysis of what had been developing in Indonesia’s economics and finance had been with me for some time. It started around the middle of my five-year term as Governor of Bank Indonesia, when the Bank commissioned a team to write a history (Rahardjo 1995). The idea was to write about my experience as well as assessment of the management of the national economy, as viewed from the Indonesian central bank. Due to the crisis that struck Indonesia in early July 1997, I decided to work on the Indonesian crisis first. With my dismissal, I wanted to write about what I had observed, analysed, and decided during the crisis in my capacity as one of the key Indonesian economic policymakers . I told President Soeharto about this plan during my last meeting with him at his residence. I ultimately wrote a book, Mengelola Bank Indonesia dalam Masa Krisis (Managing Bank Indonesia during the Crisis) and Bergulat dengan Krisis dan Pemulihannya (Fighting the Crisis and Its Recovery). Both were written in Bahasa Indonesia, and were published in October 2001. The present book is a revised English version of the first book. The Indonesian crisis as a part of the Asian crisis has been analysed and reported on extensively. It has also been widely discussed at many conferences and seminars. Many have argued that the Asian financial Reproduced from Bank Indonesia and the Crisis: An Insider’s View by J. Soedradjad Djiwandono (Singapore: Institute of Southeast Asian Studies, 2005). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available at 14 Chapter 1© 2005 Institute of Southeast Asian Studies, Singapore crisis was the worst since the Second World War. Meanwhile, the Indonesian crisis has been portrayed as the worst case in the Asian crisis as measured in terms of different economic and social indicators and the depth and spread of its negative impacts. The Indonesian crisis originated from an external shock in the foreign exchange market that contagiously caused a drastic depreciation of the rupiah, then became a total crisis. The shock in the foreign exchange market that originated from the Thai baht crisis produced a chain of effects that exposed structural weaknesses in Indonesia’s economy, and its socio-political fabric, which were hitherto hidden by high economic growth. Structural weaknesses were widespread in the Indonesian economy, both in the financial sectors, banking in particular, as well as the real sectors, in investment, production, and consumption activities. Weaknesses had also become embedded in Indonesia’s social and political system. All these problems were known and even felt by the general public. However, the public did not seem to be too concerned, as if everyone had been mesmerized by Indonesia’s high economic growth. This book aims to explain and assess what happened during the crisis as an historical record of a very important, albeit difficult period, such that some lessons can be derived in the efforts for national development. Since this is a personal assessment, the materials being used may be far from adequate. It is only hoped that what is written here will add to the existing record, while the analysis and assessment presented will stimulate more studies. It is my hope that this book will contribute to decision-makers in the government, bankers, academics, and the interested public in understanding and appreciating the issues and problems as well as policies adopted by the Central Bank and the government with respect to the crisis in Indonesia. Outline of the Issues The issues emanating from the Indonesian crisis are the following: • First, the monetary policies adopted by the government throughout the period. Before adopting a free-floating exchange system, Indonesia relied on a managed floating system that was Introduction 15© 2005 Institute of Southeast Asian Studies, Singapore combined with a creeping depreciation of the rupiah to maintain realistic exchange rates. In its implementation, the exchange rate management was aimed at avoiding overvaluation of the rupiah that complicated exports or undervaluation that could encourage capital flight. This system was adjusted to market conditions, whereby the rupiah was allowed to float more freely by adjusting the intervention bands of Bank Indonesia, in the nature...