The IMF and the Indonesian crisis

This paper considers the reasons for the seriousness of the Indonesian currency crisis of 1997-98, and the appropriateness of the IMF response, and offers suggestions for how the crisis could have been better handled. The author argues that while the IMF did not provide the best possible advice, the IMF policies most commonly blamed for the crisis – overly tight money and fiscal policy, and overly demanding structural conditions – cannot, in themselves, have been responsible for the extent of the crisis in Indonesia.

The paper argues that in the early stages of the crisis, the IMF provided inappropriate policy advice because it:

• failed to recognise and rectify the problem of a critical shortage of liquidity
• misassessed the nature of capital flows in and out of the economy
• demanded structural reforms of the economy which were ineffective in addressing the concerns of investors
• drew lessons from the 1992 crisis in Mexico and from the experience of Thailand, and failed to recognise essential differences in the underlying problems
• the G10/IMF mindset of the time and strong commercially driven opposition to any bailing-in process restricted the range of responses.

However, the author also suggests that the IMF further undermined investor confidence because it failed to understand and respond to the political environment, set inappropriate and overly demanding loan conditions – thereby setting the government up to fail – and developed a publicly antagonistic relationship with the government. This was largely the consequence of the modus operandi of the IMF: the Fund’s policy advisors changed frequently and relied on short visits, and thus failed to gain important insights into the situation and were unable to develop positive relationships with the government. Further, the Fund had to be responsive to detailed and often ill-informed US-led policy interventions from the Executive Board in Washington.

The paper proposes several options which the IMF might have considered, including:

• advising creditors to pursue debt rescheduling and debt for equity swaps
• better management of the bank restructuring and liquidity support for remaining banks to reduce currency depreciation
• the banking system could have been substantially reformed at a lower cost
• exploring alternative options for intervening on the exchange rate
• establishing a team with an ongoing presence in Indonesia with sufficient seniority and authority to carry on substantive negotiations and policy discussions, to establish an ongoing policy dialogue, and which would have been able to operate more flexibly.