Michael Shari, Jakarta – Indonesia is preparing to take stern measures to regulate its debt-plagued financial system. The new government of President Abdurrahman Wahid plans to audit large military expenditures, punish violators of toughened regulations, and raise capital targets for state banks, according to a confidential government document obtained by Business Week Online.

The document is the most convincing evidence yet that the recently elected Wahid has mustered the political will required to clean up errant financial institutions and expose mismanagement – at both government agencies and commercial banks. To prove his determination, Wahid sacked the chairman of Indonesia's Trust Resolution Corp. on January 12 for failing to get tough on politically connected debtors.

He is also seeking the resignations of the central bank governor and the president of Indonesia's largest state-owned bank. Economists in Jakarta say these developments could set the stage for an unprecedented level of compliance with the new regulatory agencies, rules, and targets that are described in the document.

Entitled Memorandum of Economic & Financial Policies: Medium-Term Strategy & Policies for 1999-2000 and 2000, the 42-page document is signed by Coordinating Minister for Finance, Economy & Industry Kwik Kian Gie and Bank Indonesia Governor Syahril Sabirin. Economists familiar with the document describe it as the basis of a new "letter of intent" that the Indonesian government is scheduled to sign with the International Monetary Fund on January 20 as a condition of continued IMF aid.

The document says the measures will be part of a "new economic program" that will require more IMF funding – in an as-yet unspecified amount – through December, 2002, and will "replace" an earlier "extended arrangement that was approved on August 25, 1998," by the IMF.

Confidence in Indonesia's financial system was badly shaken on December 31, when Kwik announced that an independent audit of Bank Indonesia by KPMG had found that the central bank was in the red to the tune of $7 billion. Wahid responded by asking Sabirin to resign in a closed-door meeting. Sabirin refused, citing year-old legislation that made the central bank independent – and also made it impossible for the President to sack the central bank governor.

Then, on January 12, Sabirin sacked Indonesian Bank Restructuring Agency Chairman Glenn Yusuf for delays in asset disposal, and for failing to blow the whistle on the disappearance of $80 million from the accounts of Bank Bali, in which the former ruling Golkar Party was involved.

Heads will roll next at Bank Nasional Indonesia 1946, the country's largest state-owned bank, which is named after the year it was founded. Sources close to the Finance Ministry say BNI President-Director Widigdo Sukarman will resign, accepting responsibility for allowing Texmaco Group, a textile and petrochemical conglomerate that was supported politically by former President Suharto, to accumulate more than $1 billion in bad debt. This move is intended to make way for a massive recapitalization program at BNI by the middle of the year, which will be financed by some of the $28.6 billion in new bonds that the government plans to float by mid-2000, according to the document.

And that's just the beginning of Wahid's show of strength. According to the document, the government plans to begin two separate audits this month. The first will "consolidate all information on all bank accounts of off-budget activities" in what a well-informed Jakarta banker says is an attempt to curb corruption among government officials. The second audit will focus on "all military-related funds" that involve "significant financial exposure." The Jakarta banker says this is an effort to curtail the role of army generals in high-risk investments such as real estate. "These audits will be initiated by the BPK [an acronym for the Supreme Audit Board] in January, 2000, and will be expected to be completed by June 30," the document says.

In addition, a new "independent financial supervisory agency" is to be created by 2002 for "prudent supervision of the financial system," the document says.

As part of this tightened supervision, the government will soon require that all foreign-exchange transactions in excess of $10,000 be reported to the central bank. This is an unprecedented move that Indonesian economists say is intended to stem capital flight.

Powers and penalties

At the same time that the government is planning to stiffen existing penalties, it will give the new agencies enforcement powers.

The document says the government will introduce "powerful disincentives for corrupt practices [including prosecutions of the parties that engage in such practices]" and "enhance the role of the attorney general and seek parliamentary confirmation for all appointments to the Supreme Court."

The document also says the Finance Ministry will improve the oversight of nonbank financial institutions, adopt a new code of corporate governance, and strengthen existing capital market regulation. And new legislation is to be brought before Parliament "sometime in 2000" to allow the government to audit – for the first time ever – "charitable foundations" that are linked to the government, including several that were chaired by Suharto and his wife Tien until the late 1990s.

If implemented, the new measures could make up for more than three decades of lax supervision of financial institutions that were run by revered Western-educated technocrats. They simply failed to blow the whistle on corruption and negligence in the central bank and the Finance Ministry under Presidents Suharto and Habibie from 1965 to 1999, complains Mohammad Sadli, a Berkeley-educated economist. "The technocrats suffered from blind spots," says Sadli. "They were naive."

Public audits

But now, after 12 weeks in office, Wahid is consolidating his influence and moving to uproot entrenched bureaucrats whose collusion with politically connected business leaders brought down the economy and crippled the central bank. Part of his show of strength is an unprecedented policy – by Indonesian standards – of auditing financial institutions, followed by public announcements of the findings.

"This is a great step forward," says Emil Salim, chairman of Wahid's new Economic Council, an advisory panel. The goal, to hear this Berkeley-educated economist tell it, is to offer investors the brutal honesty they've been demanding ever since Indonesia's capital markets and bank sector deregulated in the 1980s – and gamble that it won't scare them away.