Vincent Lingga, Jakarta – In early July 1997, when the Thai baht crashed and lost more than 50 percent of its value against the dollar immediately after the Bank of Thailand floated the local unit, Indonesia was an innocent, unaffected bystander, its rupiah stable at around Rp 2,500 to the dollar.

However, what was initially perceived simply to be a baht crisis quickly spread to Indonesia, Malaysia, the Philippines and South Korea, stripping bare their economic and political weaknesses and causing Indonesia to suffer the deepest ever plunge in the value of its currency and the most massive wealth destruction any country had seen since the early 1940s.

Foreign portfolio investors and creditors who got burned in Thailand and suffered from asset inflation, misallocated capital and inadequate regulation of the financial services industry reassessed Indonesian economic prospects against the lessons they learned in Thailand.

The Indonesian rupiah came under strong speculative attack immediately after investors and analysts found that Indonesia's economy had shared most of the diseases that led to the financial debacle in Thailand.

Bank Indonesia initially defended the rupiah by direct market intervention, dipping into its foreign reserves and raising interest rates to tighten money supply.

However, as the demand for dollar did not decrease and the attacks on the rupiah became even stronger after the Philippine peso and the Malaysian ringgit were devalued, Bank Indonesia decided to float the rupiah on Aug. 14.

The float did take pressure off the central bank's foreign reserves, but the drastic move left the currency fully exposed to the negative market sentiment, causing panic among most national businesspeople who had been comfortable for decades with the "crawling" peg of the rupiah, with an annual depreciation of 3 to 5 percent.

Within less than two weeks, amid the scramble for dollars by companies that wanted to retire their foreign debts, the rupiah tumbled to Rp 3,000 and the Jakarta stock market lost a staggering 35 percent from its peak in early July.

Hundreds of companies with unhedged foreign debts but with revenues mostly in rupiah were threatened with insolvency. The central bank's tight money policy – interest rate rose to as high as 30 percent – to encourage investors to hold the local unit made things even worse as Bank Indonesia was completely in the dark about the magnitude of corporate foreign debts.

As the financial condition of most companies and consequently commercial banks worsened, international banks were unwilling to do business with domestic banks, even refusing to accept letters of credit from most Indonesian banks.

The El Nino impact of a prolonged drought in the second semester of 1997 that damaged food crops and plantation commodities compounded the economic woes, thereby setting off a vicious cycle of pessimism and massive capital flight.

The steady rise in interest rates and the steady weakening of the rupiah also revealed the critical weaknesses of corruption, collusion and nepotism – in which most business was done.

In early October, as the rupiah had lost more than 30 percent of its value to hover at Rp 3,800, the government invited in the International Monetary Fund. But the US$43 billion rescue package concluded with the IMF at the end of October failed to improve investor confidence.

In a drastic move that the IMF eventually admitted as a grave mistake, the multilateral institution recommended the closing of 16 insolvent banks, including several owned by members of the Soeharto family.

In the absence of any kind of deposit insurance program, the bank closure panicked depositors and prompted massive deposit withdrawals from most other private banks.

Then president Soeharto instructed the central bank, in contravention of its tight money policy, to inject liquidity (emergency liquidity credit) into troubled and cash-trapped banks in a bid to contain the panic. However, bank runs and capital flight continued.

Bank Indonesia reports showed that from October 1997 to January 1998, cash in circulation increased by a staggering 50 percent and the supply of base money (M1) expanded by almost 40 percent.

The two contradictory policies – massive money expansion and punitively high interest rates at over 60 percent – further damaged the economy, causing the rupiah to fall even lower and consequently doubling consumer prices.

Bank Indonesia reports showed that around Rp 145 trillion in emergency liquidity credits were injected into private banks between October 1997 and March 1998.

But eventual audits found that only about one-third of that amount was paid to depositors as the bulk of the credit was abused by bankers and bank owners to buy foreign exchange and shift assets overseas, to repay subordinated loans of the majority shareholders and to settle derivative contracts.

Hence, much of the ballooning quantity of the rupiah wound up being sold for dollars on the open market and shifted to Singapore and Hong Kong and other offshore locations by Indonesians desperate to get their money out of the country.

The collapsing rupiah and the bankruptcy of most banks and big business groups began to erode Soeharto's political legitimacy.

As 1997 closed, the rupiah had lost almost 75 percent of its value and the stock exchange 80 percent of its market capitalization as many companies and banks simply went bankrupt, millions of people were thrown out of jobs and the severe drought caused fears of food shortages.

The beleaguered Soeharto defied market sentiment and announced in early January 1998 a new state budget that was seen by the market as grossly unrealistic, causing the rupiah to crash through the Rp 10,000 level.

Panicked people rushed to strip supermarkets and grocery stalls bare of rice, cooking oil, noodles, flour, sugar and biscuits.

Soon after, a high-powered IMF team arrived in Jakarta and, in cooperation with the World Bank, revised its rescue package with bolder and painful reform measures.

However, the market reacted negatively to the IMF-World Bank rescue package of Jan. 15, apparently skeptical that Soeharto would implement all the reform measures.

Soeharto again stunned the nation and the international market on Jan. 20, 1998, when he unveiled then big spender minister of research and technology B. J. Habibie as his surprise choice for vice president for the March 1998-2003 term. The rupiah fell through the Rp 17,000 point on Jan. 23.

Market sentiment was further damaged when Soeharto, fresh from being reappointed to the 1998-2003 term in mid-March, announced a crony Cabinet lineup that included his eldest daughter and notorious businessman Muhammad Bob Hasan.

The president incited massive street protests when on May 5 he went ahead with raising fuel prices by more than 70 percent as part of the reform measures agreed to with the IMF.

Street demonstrations and rioting which started immediately in Medan, North Sumatra, quickly spread to cities in Java and exploded into a bloody incident in Jakarta on May 12, with four students from Trisakti University killed by troops.

This tragedy set off massive rioting and looting in Jakarta on May 14 and 15 and eventually led to the fall of Soeharto on May 21, 1998.

The Indonesian crisis is thus a tale of mistakes piled atop mistakes, misjudgments by the IMF and the Indonesian government, and bureaucratic wrangling between the IMF and the World Bank.

[The author is a staff writer at The Jakarta Post.]