Darren Mcdermott – Indonesia's financial system is teetering on the edge of paralysis.

As companies make a mad grab for scarce dollars, the country's currency is plunging – down as far as 32% on Thursday alone. Amid such stomach-wrenching drops, some Indonesian banks are failing to hold up their end of transactions and some international bankers are cutting off all funding to Indonesian borrowers and bracing for a debt moratorium. In sum, the gears of the country's financial system are jamming.

"Everybody's avoiding the word 'standstill,' everybody's avoiding the words 'major rescheduling summit,' but everyone knows that it's just days away," says the regional head of a U.S. bank in Singapore.

Indonesia faces financial breakdown on two fronts. First, there's the matter of some $65 billion or more that Indonesian companies owe foreign banks. Many Indonesian companies ceased repaying foreign loans weeks ago, and fears of a government-imposed moratorium are once again on the rise. But more urgently now, the daily transactions of commerce that make up the lifeblood of an economy are in danger of grinding to a halt, bankers say. "Every day you wonder, is this going to be the last day?" says the bank executive, who, like other senior bankers interviewed for this article, spoke on condition of anonymity.

Deepening Worries

At the outset of trading Thursday, the rupiah went into free fall. This was rooted in jitters over the financial system combined with deepening worry over how Indonesia will deal with what has turned into a huge political crisis. A growing number of bankers, investors and fund managers say last week's revised International Monetary Fund program for Indonesia has failed to boost markets mainly because 76-year-old President Suharto himself is a big part of Indonesia's problems.

Worry about Mr. Suharto intensified – and the flight from the rupiah has been fueled - - by strong speculation he may choose controversial Research and Technology Minister B.J. Habibie for his vice president for a new five-year term expected to begin in March. So abrupt was Thursday's rupiah slide that market participants were unable to agree just how low the rupiah fell, though at least one bank reported a trade at 17,100 rupiah to the dollar, a 32% fall from Wednesday's closing level of 11,575 rupiah. Indonesia's central bank eventually stepped into the market twice to buy rupiah, bringing the currency back to around 11,850 late in the Asian day.

But the damage was done. The rupiah's dive sent the Jakarta stock exchange down 4.8% and was blamed for a regionwide retreat; stocks fell in every other Asian market save Shenzhen, China, while currencies around much of Asia also weakened.

Valuable Dollars

As the Indonesian rupiah has plunged, companies have hoarded increasingly valuable dollars. With a shortage of dollars in the system and their price rising daily, Indonesian banks are struggling to make good on day-to-day transactions with international parties such as honoring checks and trade-related credits, as well as foreign-exchange deals. In the past two weeks, most large Indonesian banks have had to plead for extra time in settling transactions with foreign banks, according to senior bankers in Singapore, where the bulk of daily trading in the rupiah takes place.

Applying pressure could push the system into gridlock, in which the complex flow of banking-system payments freezes as each bank refuses to make a payment until it receives one from another party. As a result, Singapore bankers say that so far they have allowed Indonesian banks time to scrounge up the needed cash. But it makes them very nervous; they're growing reluctant to deal with Indonesian parties. And fewer players in a market makes it more volatile, the last thing the beleaguered rupiah needs.

"The system is close to collapse unless there is some stability returned," says a prominent Indonesian businessman. "It can't endure the rupiah at this level."

But bankers now expect that the government will be forced to block foreign-debt repayments, shut the gates on capital flows or otherwise restrict the rupiah's trading. The government said two weeks ago that there would be no moratorium on debt payments, a move that would be tough to get past the IMF.

Financial-System Freeze

But that was before the latest IMF package, a tougher version of a November agreement that Jakarta strayed from, was formulated – and flopped. The IMF is expected to push Indonesia to keep its capital account open, and to refrain from bailing out the companies that have accumulated heavy debts. But if the falling currency and mounting debts trigger a financial-system freeze, the government may have no choice but to take some of these measures.

"It's got to the point where some foreign bankers are saying, 'Why don't we just trigger it ourselves and get it over with,' " says one banker. "At least then we'd know where we stand."

A moratorium might also prove ineffective or destructive, some economists say. "It seems like an easy thing to do," says Tim Condon, economist at Morgan Stanley Dean Witter. "But experience shows that it's unlikely to stabilize the currency unless it's accompanied by far-reaching economic reforms."

Government officials and bankers who have met with them hint that a major announcement carrying out the reforms agreed to last week with the IMF is on the way, possibly within days. The past week has seen positive steps as three large bank mergers materialized, and another was formally announced. Indonesia's bloated banking sector could shrink from more than 200 banks to fewer than twenty. But while that would have wowed the market three months ago, it's no longer enough. "Just because you merge 10 insolvent banks into one insolvent bank doesn't mean your work is done," says Christa Marti, an economist at UBS Securities in Singapore.

'Very Confused'

But it's unclear what else the government has to offer, if anything. "They seem very confused," says a banker who met with top economic-policy officials this week. Similarly, executives who have met Indonesian central-bank officials in recent days report inaction – "like a rabbit caught in the headlights," says one.

On Thursday, debt problems arose when Mr. Suharto met a senior Japanese official. After the meeting, Tokyo said it was ready quickly to disburse as much as 50 billion yen ($393.4 million) in additional aid to Jakarta. The official Antara News Agency quoted State Secretary Murdiono as saying afterward that the president "is thinking hard how to help ease the private sector's debt problem without harming creditors."

Jakarta bankers say they believe the government is trying to find a way to have a moratorium – without formally declaring one. "They are striving to find a way to not use the 'M' word," one banker said, noting that declaration of a moratorium could shut off new capital for years. But it isn't clear how to begin a government-directed debt restructuring that's acceptable to creditors.

And as time passes without talks beginning on how international banks and their hundreds of Indonesian borrowers will work out agreements to restructure the country's foreign debt, confidence in Indonesia's ability to cope dwindles. A visit to Singapore-based creditors by Indonesia's point men on a debt workout two weeks ago resulted in just one agreement: that the officials should return with an exact count of the country's outstanding foreign debt, which they still lack, according to bankers who attended.

Going Nowhere

Creditors themselves remain splintered. A handful of international banks have been meeting in Singapore as recently as Thursday in an attempt to fashion a framework for the day when negotiations do begin, but so far with little progress. "It's going nowhere," says one banker familiar with the talks. "We are nowhere near even an intellectual starting point."

With no talks on how to handle the debt, economists say the rupiah will continue to fall. With imported food costs soaring as a result, observers now worry about next week's nationwide religious celebrations. The rupiah's fall two weeks ago to levels even stronger than Thursday's set off widespread panic buying and hoarding of basic goods. And the Lebaran holiday, which marks the end of the Islamic fasting month, entails large feasts and gift-giving that will further stretch already tight household budgets. Social strains may prove greater in February when layoffs are expected and a price freeze on basic goods is lifted.

And so, the thinking among some bankers goes, Jakarta may then reach for a blunt instrument, such as a moratorium, to stop the rupiah's fall and bring prices back under control.

"I think they are trying to make it through Hari Raya and I don't think they stand a chance," says one regional head of credit who says he has already shut down virtually all lending to Indonesian borrowers, including trade finance. "We're strapped down for heavy weather."

[Staff reporters Richard Borsuk and Norihiko Shirouzu, and Jay Solomon and Kate Linebaugh of Dow Jones Newswires contributed to this article.]