Crisis in Indonesia: Economy, Society and Politics

Current Issues Brief 13 1997-98

Dr Stephen Sherlock
Foreign Affairs, Defence and Trade Group
8 April 1998


Major Issues Summary


Indonesia's Economic Crisis

Origins of the Crisis
The Crisis Hits Indonesia
The Government's Response-Reform and the IMF

Social Effects of the Crisis

Inflation and Food Shortages
Job Losses, Unemployment and Underemployment
An End to Affluence, a Return to Poverty

The Politics of Crisis-President Soeharto and the New Order

President Soeharto and the Army
The Vice-President and the Army
Change from Below: A People's Power Movement?

The Implications for Australia

From Weakness to Strength: Indonesia-Australia Relations
Australia and the Region
Australia's Response



Appendix: Australia's Trade with Indonesia

Map of Indonesia

Major Issues Summary

The Asian currency crisis arose from a collapse of confidence in the ability of a number of countries to maintain their fixed exchange rates while continuing to allow the free movement of foreign finance capital at a time of increasing current account deficits.

The Indonesian rupiah was initially not affected by the pressure on other regional currencies. When it begin to fall, however, the underlying weakness of the Indonesian financial sector was revealed and private foreign debt was far higher than previously thought. The crisis worsened in Indonesia because of the lack of an effective government policy response.

The International Monetary Fund (IMF) financial stabilisation package agreed to by the Indonesian Government contained conditions requiring Indonesia to reform its financial sector, reduce fiscal expenditure and radically change the nature of government involvement in the economy. Disagreements between the Indonesian Government and the IMF over implementation of the reforms have become the focus for controversy about the role of the IMF. Much of the controversy derives from the fact that the IMF offered a combination of financial rescue package and economic reform program. The IMF has been criticised for applying a formula which was inappropriate for Indonesia, was too difficult to implement in the time allowed and did not alleviate the immediate problems. The IMF position is that while the details of the package can be renegotiated, such crises will recur unless Indonesia's economic institutions are reformed.

The currency crisis has combined with the effects of drought to produce rapid inflation, especially in the cost of food and other essentials, and a great increase in unemployment and underemployment (8.7 million and 18.4 million respectively, 30 per cent of the workforce). The return of poverty for many Indonesians and the end to short-lived affluence for others has shattered the expectations, created by the economic achievements of the New Order regime, that Indonesia was on the path to continued growth and prosperity.

The New Order regime based its legitimacy on a capacity to bring sustained improvements in the standard of living of the mass of Indonesians and to meet the aspirations of an expanding middle and working class. The apparent end to this success will have grave implications for the political stability of the Indonesian state. The crisis has been a psychological blow to confidence that Indonesia had finally overcome its long history of economic and political instability and was set on a long-term path to prosperity.

Indonesia has been transformed from a country with a tiny social elite and a mass of impoverished peasants to a rapidly urbanising society with new social groups less willing to trade political rights for personal prosperity. There is increasing resentment about the domination of economic and political life by President Soeharto and his family and the suppression of free political expression by the Army and Government.

There appears to be a widespread feeling within the Army that Soeharto should step down from power, but senior officers are not yet prepared to express their feelings openly. The new Vice-President, B. J. Habibie, is not popular with the Army and it is an open question if the Army would support Habibie becoming President if Soeharto were to die or retire. These doubts underscore the uncertainty created by the question of the transition from Soeharto's rule.

The crisis has raised the possibility that many ordinary Indonesian people may join in spontaneous or organised movements of mass protest, perhaps even a 'people's power' movement like the one that toppled President Marcos of the Philippines. Recent years have seen the growth of NGOs, labour unions and Islamic organisations, but civil society has been stultified by thirty years of tight New Order political control. There have been sporadic riots and the emergence of a pro-democracy student movement, but the Army has crushed the riots and kept student protest confined to the universities. The outbreak of major riots would put great pressure on the factionalised Army and would raise the question of whether it would move against Soeharto.

The crisis in Indonesia has significant implications for Australia because Indonesia is now a major strategic and economic partner for Australia. Indonesia has an important role in the Asia-Pacific region where Australia's crucial interests lie. The Australian Government has provided emergency assistance to Indonesia and financially supported the IMF program as well as attempting to assist overcome disagreements between Indonesia and the IMF.


This year was certain to be one of some political tension in Indonesia because the country was due to go through the five-yearly process of selecting a President. But the unexpected appearance of severe economic problems in Indonesia has combined with the uncertainty caused by the presidential succession to become a political and economic crisis of major proportions. Even before economic troubles developed, there were clear signs of growing discontent with President Soeharto's Government. Popular dissatisfaction has arisen over the suppression of democratic politics, as well as concerns, at both a popular and elite level, about the weakness of governmental institutions under the highly personalised rule of an aging President. A number of other Southeast Asian countries have come under great economic stress since mid-1997, but none have experienced a crisis like Indonesia's, nor had their political problems exposed in such a way. The events of recent months have revealed many of the problems and conflicts in Indonesian society, politics and economy.

President Soeharto established his New Order regime after a coup in 1965 and has successfully maintained political unity in the disparate Indonesian archipelago and presided over sustained economic growth and development. The ageing President's unwillingness to step down from the presidency after over thirty years in office, however, and his refusal even to countenance any serious consideration of his eventual succession has underscored the fact of how much the stability and growth under the New Order regime since 1965 has depended upon Soeharto as an individual.

Political power has been concentrated in a few hands, mainly in the Armed Forces of Indonesia (ABRI) and a number of civilians related to or close to President Soeharto. Constitutional organs such as parliament are mere rubber stamps. Similarly, the impressive economic development under the New Order has been under the control of a small number of business organisations dependent on the direct patronage of the President and his extended family. The lack of progress towards the development of political institutions has been revealed by the Indonesian Government's seeming incapacity to respond to the currency crisis in an effective manner.

This paper briefly examines the origins of the currency crisis affecting a number of countries in East and Southeast Asia and then focuses on the crisis in the Indonesian economy and stalled efforts by the IMF to develop a program to stabilise the Indonesian currency and reform the country's economic institutions. The paper examines the social effects of the crisis and the impact on the well-being of ordinary Indonesians. It discusses the political dimensions of the crisis against the background of concerns about the succession from President Soeharto and the growing pressure for political liberalisation, pressure which has in part been created by the very achievements of the New Order since the 1960s. The paper concludes by examining the implications of the Indonesian crisis for Australia and considers the prospects for a resolution of Indonesia's current economic and political turmoil. The paper can be read in conjunction withThe Politics of Change in Indonesia: Challenges for Australia, Parliamentary Research Service Current Issues Brief No. 3, 1996-97.

Indonesia's Economic Crisis

The background to the major problems that have emerged within Indonesia's finance and banking system is, of course, the rapid fall in exchange rates in other Southeast Asian countries such as Thailand, South Korea and Malaysia since mid-1997. These trends have been exacerbated by continuing sluggish growth in Japan. These events have become well known in the Australian media under labels like the 'Asian economic crisis' or 'Asian financial meltdown'. Such descriptions are fairly misleading, however, because the crisis has by no means affected the whole of Asia (China, Taiwan and India have escaped serious problems) and the effects have varied greatly throughout the region. While the majority of commentators consider that most of the affected countries will have returned to economic health within one or two years, there is much less optimism about Indonesia because the country's political weakness has meant that Jakarta has not yet developed an effective policy response. The prospect of political turmoil is certain to undermine foreign investor confidence in Indonesia, deterring the inflow of the foreign capital essential for restoring the value of Indonesia's currency, the rupiah, and for restarting economic growth.

Origins of the Crisis

The crisis resulted from a collapse of confidence in the ability of a number of Southeast Asian countries to maintain their fixed exchange rates while continuing to allow the free movement of foreign finance capital at a time of increasing current account deficits.(1) The system of pegged exchange rates was one of the fundamental features underpinning the sustained economic growth in Southeast Asia during the 1980s and 1990s because it provided certainty to investors and encouraged Japanese manufacturers to relocate to Southeast Asia to escape competitiveness problems caused by the highly-valued yen. Difficulties began to develop in the mid-1990s, however, when three key currencies in the region, the US dollar, the Japanese yen and the Chinese renminbi, underwent major shifts in their relative value. In 1994 the Chinese currency was devalued by 50 per cent against the dollar and between 1995 and 1996 the yen fell by 40 per cent against the dollar.(2) This increased the competitiveness of Chinese and Japanese goods and made exports from Southeast Asia more expensive since their currencies were still pegged to the rising US dollar. Exports from the region rapidly lost their competitiveness and ceased their previous continuous growth. Thailand, for example, went from a 25 per cent growth in merchandise exports in 1995 to zero growth in 1996. Export growth was also affected by economic slowdown in Europe and Japan and by increasing US textile imports from Mexico following the signing of the North America Free Trade Agreement (NAFTA).(3)

The first to show signs of crisis was Thailand where the increasing current account deficit put pressure on Thai authorities to defend the baht by greatly increasing interest rates. This move, however, only exacerbated problems by causing the collapse of many heavily indebted companies, particularly in the inflated property market. This in turn worsened the problems of the financial sector which was saddled with growing numbers of non-performing domestic loans and huge foreign debts of short-term or 'hot money'. With foreign currency speculators expecting the Thai Government to devalue, there was a selling attack on the baht in February 1997. The government responded by selling billions of dollars in foreign exchange reserves to support the baht, a move which was initially successful but soon faltered in the face of an increased attack on the currency during the year. In July 1997 the Thai Government was forced to abandon the pegged currency and by September 1997 the baht had collapsed to 38 to the US dollar, down from the 25 to the dollar in July.(4)

The Crisis Hits Indonesia

The Indonesian rupiah was initially not affected by the pressure on other regional currencies in early 1997 because it did not appear to suffer such acute problems of a large current account deficit and high dollar-denominated foreign debt. For several years the Indonesian central bank (Bank Indonesia) had also allowed the rupiah to float within a range of 8 per cent, allowing a 4-5 per cent annual depreciation from 1995. When the Thai, Malaysian and Filipino currencies began to weaken in early July 1997, Bank Indonesia took the pre-emptive measure of increasing the band within which the rupiah could float from 8 per cent to 12 per cent. By the beginning of August, however, the rupiah appeared to have caught the 'contagion' and was falling below the 12 per cent band. Bank Indonesia was forced to allow the currency to float freely and by the end of October it had fallen from the June 1997 rate of around 2400 to the dollar to a new low of 3600 to the dollar.(5)

The rapid fall in the rupiah, beginning in July-August 1997, soon revealed the underlying weakness of the Indonesian financial sector. Panic selling of rupiah for dollars by Indonesian companies with dollar-denominated debt showed that private foreign debt was far higher than previously thought. Worse still, the fact that Bank Indonesia was unaware of the extent of the debt showed its poor capacity to oversee and regulate Indonesia's financial markets. As in Thailand, much of the foreign debt was short-term and due for repayment within twelve months and, with the continuing fall in the rupiah, was increasingly difficult to service.

The impact on many banks was rapid and calamitous. The Government liquidated 16 private domestic banks in November. The lack of confidence in the banking sector was dramatically demonstrated later that month when rumours of the death of the major shareholder of Indonesia's largest private bank, Bank Central Asia, almost sparked off a run on the Bank.(6) Meanwhile the rupiah continued to fall far beyond all predictions. By the beginning of January 1998 the Indonesian currency had tumbled to 10 000 to the dollar, a 75 per cent devaluation since mid-1997. By the end of January the rupiah fell to its low-point of 17 000 to the dollar and has traded in the 9 000 to 10 000 range since that time. This was also accompanied by a deep slump in the stock market, with the index falling from 720 in July to 600 in August and falling a total of 75 per cent by mid-December.(7)

The Government's Response-Reform and the IMF

The Indonesian Government's initial response to the pressure on the rupiah was generally seen by commentators and financial analysts as pragmatic and decisive. As well as floating the currency and increasing interest rates, a number of policy announcements in September included plans to reorganise the banking sector, cut some tariffs and facilitate exports, postpone or review large capital-intensive development projects and eliminate certain restrictions on foreign equity in Indonesian companies.(8) The short calm soon passed by, however, with a further collapse of confidence in regional currencies. This followed comments by Malaysian Prime Minister, Mahathir, blaming the problem on international financier George Soros. Confronted with a renewed fall in the rupiah, on 8 October 1997 the Indonesian Government approached the International Monetary Fund (IMF) for financial support.

When approaching the IMF, President Soeharto reportedly sought only a small financial package without conditions attached.(9) As the magnitude of Indonesia's problems became apparent, however, a much larger agreement was negotiated with the IMF. On 31 October the IMF announced a $US23 billion rescue package (with contributions from the World Bank and the Asian Development Bank) designed to stabilise Indonesia's currency and restore confidence in its financial markets. It also included a number of conditions aimed at restructuring the country's financial sector and deregulating the economy, cutting government expenditure, reforming trade and industry policy and improving transparency in relations between business and government.

The last condition was especially sensitive because it involved dismantling the monopolies and special assistance provided to businesses and projects owned by the family and close associates of President Soeharto. Such special concessions have been one of the main targets of popular resentment within Indonesia and, internationally, have become the symbol of the 'crony capitalism' which has undermined confidence in the Indonesian economy.

A second IMF agreement in January 1998 set out in more detail a program designed to prevent an economic contraction, contain inflation to 20 per cent in 1998 and move the current account from deficit into surplus. The agreement specifically mentioned the elimination of support to the aircraft industry and the National Car project, the restriction of the BULOG (Indonesia's food distribution agency) trade monopoly on the import of rice, deregulation of domestic trade in all agricultural products, including cloves (a major ingredient of Indonesian cigarettes) and the dissolution of cartels in the important cement, paper and plywood industries. The Government also agreed to phase out energy subsidies by gradually increasing the price of fuel and electricity, but limiting price increases for kerosene used for domestic cooking.(10)

Issues regarding implementation of the IMF rescue package have assumed centre stage of debate about the future of the Indonesian economy. Despite President Soeharto's public commitment to implementing the reforms in the plan, it soon became apparent that he was reluctant to accept their full implications. The first sign was Soeharto's apparent desire to use the additional $US11 billion financial assistance offered by Japan, Singapore, US, Malaysia and Australia in October 1997 as a less conditional source of money which might strengthen Indonesia's hand in negotiations to soften the terms of the IMF loan. Further indications were that Soeharto wanted to protect the monopoly of basic commodities trade held by BULOG and to maintain funding for the heavily-subsidised state-owned aircraft industry overseen by his closest political associate, Habibie. The day after signing the IMF package, Soeharto also signed a decree allowing a number of the projects postponed or placed under review in September to proceed. Such signals of unwillingness to carry out the intention of the IMF agreement caused any restoration of confidence in the rupiah to be very short-lived and to lead to its continued downward spiral. The picture was worsened by the public refusal by certain members of Soeharto's family to accept closure of their failed banks.(11)

The IMF formula has come under criticism, from differing points of view, that its recommendations are inappropriate for Indonesia's economic circumstances. Some critics contended that providing emergency loans created 'moral hazard', encouraging the governments of other developing countries to adopt irresponsible economic policies with the assurance that the IMF would come to their rescue. Others have criticised the conditions attached to the loans, arguing that cutting government expenditure and high interest rates has led to an unnecessarily deep recession. The argument is that the IMF's financial stabilisation packages tend to follow a standard formula which evolved to treat economies experiencing hyper-inflation and bloated fiscal and current account deficits (especially in Latin America), but which was inappropriate for Indonesia where these problems were not significant and where fiscal and macroeconomic policy had generally been quite orthodox. There has also been criticism of IMF pressure for cuts to subsidies for basic consumer commodities as worsening the plight of many already impoverished Indonesians.

Much of the reason for controversy surrounding the IMF program derives from its character as a combination of financial rescue package and economic reform program. The IMF has been criticised for using loans designed for immediate stabilisation to force Indonesia to adopt major policy reforms, the scope of which would be difficult for even a developed country such as Australia to introduce in such a short time. A number of commentators have argued that an international financial institution has no place enforcing a program which appears to be aimed at applying pressure for political change within Indonesia and which, it is argued, infringes Indonesia's sovereignty. From the point of view of the IMF, however, there is little point providing emergency finance to stabilise the Indonesian currency if the structural problems seen to be behind the crisis are not ameliorated. The Fund also considers that confidence in the Indonesian currency will not be restored unless international investors are reassured that the Indonesian Government is prepared to take measures which confront the structural problems in the economy, despite the political and social pain they may cause.(12)

With the Indonesian Government showing itself to be increasingly uncomfortable with the IMF reform program, some observers have seen the situation in Jakarta since late last year as one of virtual policy paralysis. While the Indonesian Government has been inconsistent in its commitment to implementing reform, it has done little to develop alternative policies, even for the short term. A proposal to introduce a Currency Board system, under which each rupiah would be backed by US dollar reserves, was widely criticised as unworkable and aimed at securing the assets of powerful business interests rather than in solving the country's currency problems. Moreover, the indecisive debate over the proposal occupied several months of precious time, during which Indonesia's economic difficulties have become increasingly urgent. The Government's incapacity to come to terms with the depth of the problems it faces was also seen to be exemplified in the Budget delivered in late 1997 which contained completely unrealistic estimates of the coming year's economic growth and fiscal balance and which had to be revised drastically downwards in a new Budget announced on 23 January 1998.

The IMF delivered the first tranche of $US3 billion in November 1997 and the second of $US3 billion was due on 15 March 1998. In the face of the Indonesian Government's apparent unwillingness to proceed with the agreed reforms at the specified pace, however, the IMF postponed delivery of the money. This move was triggered by the actions of the Indonesian Government in restructuring a number of monopolies in such a way as to preserve the influence of key individuals and in its slowness in preceding with other agreed reforms. Recent reports suggest that the IMF and the Indonesian Government are moving towards developing a new agreement. Any decision to further postpone or even withdraw financial assistance to Indonesia would have a disastrous effect on the Indonesian currency, with the certainty of a renewed collapse in its exchange value.

The IMF has been confronted with a dilemma. To continue further tranches of assistance without substantial moves by the Indonesian Government would make a mockery of its efforts to achieve long-term reform, but to withhold assistance and allow the collapse of the rupiah would damage the Indonesian economy and worsen political unrest. It would also adversely affect the economic health of the entire region. Current Indonesian Government economic projections for 1998 are for zero economic growth and inflation of 20 per cent. Many economists have already concluded that these figures are overly optimistic, with estimates of growth (or contraction) ranging from minus 3 per cent to minus 10 per cent and an inflation rate of up to 100 per cent. Interest rates are now running at between 30 and 40 per cent. At the current exchange rate of around 10 000 rupiah to the dollar, virtually every company listed on the Indonesian stock exchange is technically bankrupt. Only if the exchange recovered to around 5000 to the dollar would they be able to service their foreign debt and maintain profitable overseas trade. A continued standoff between the IMF and the Indonesian Government would have very serious implications indeed.

Social Effects of the Crisis

The most immediate and widespread effect of the economic crisis on the people of Indonesia has been accelerating inflation. During the first half of 1997, Indonesia was experiencing particularly low inflation (2.6 per cent), but the price increases of the second half brought annual inflation for 1997 to 11 per cent, compared with a rate of 6.5 per cent in 1996. Since the beginning of 1998, price increases have accelerated still further to levels which threaten hyper-inflation. Inflation for January and February 1998 was 20 per cent and estimates for annual inflation for the coming year have ranged from 40-50 per cent up to 100 or even 200 per cent.(13) Prices have risen across most sectors, but the most severe increases have been in critical areas such as food and other essentials. Food prices increased by 30 per cent during January and February. During the last year, rice has increased from 1800 rupiah per kilo to 3500 ($A0.36 to $A0.70 at April 1998 exchange rates) and cooking oil from 2000 rupiah per litre to 5500 ($A0.40 to $A1.10). The price of protein sources such as eggs, soy beans and chicken are rising beyond the reach of many low-income consumers.(14)

The most serious aspect of the food situation is that the problems caused by the falling rupiah are occurring at the same time as Indonesia is suffering its worst drought for many years. Rice production has already fallen by 10 per cent in the last year due to the effects of El-Nio and there is a strong possibility that the drought will continue into this year. Indonesia's food distribution agency, BULOG, will be forced to continue and increase its import of food staples to keep prices down and maintain food distribution. BULOG has been allowed to purchase foreign exchange at a subsidised rate of 5000 rupiah to the dollar, the effect of which is that food imports are being subsidised by the Central Bank at the cost of the country's already weak foreign exchange position. If currency and drought problems persist into the coming months, sustaining food imports will become an increasingly difficult task.

There are also doubts about the effectiveness of the distribution system in many areas, particularly in poor and remote eastern regions of the country which have been particularly affected by the drought. Shortages have been made worse in some districts by hoarding and panic buying. Nevertheless, the food situation in Indonesia has not reached anything approaching disaster proportions. Immediate stocks are sufficient and BULOG has generally proved to be effective as a food import and distribution agency in the past. Concern will mount in the second half of 1998, however, especially if the rains are poor.

Job Losses, Unemployment and Underemployment

The collapse of Indonesia's currency and the consequent exposure of the private sector to massive unrepayable foreign debt has had a devastating impact on employment, especially in urban areas. Accurate figures on the extent of job losses are impossible to obtain, but most estimates put the figure at around two million.(15) The industry which felt the most immediate effect was construction (where an estimated one million workers have been laid off) because much short-term foreign borrowing had been directed into city building and infrastructure projects. There have also been extensive lay-offs in manufacturing and in the banking and service sector as new highly-leveraged manufacturing concerns have gone bankrupt. The banking sector has virtually collapsed and industries providing services to new industries and consumers have lost their customers. Indonesia had experienced strong employment growth for the past several years, but it is the jobs in the new growth areas which have been most vulnerable to changed economic circumstances.

It is often assumed that wage-workers in developing countries can return to their villages if they lose their city jobs and, indeed, this was often the case in the past when the wage sector of the workforce was very small. But the transformation of the Indonesian economy in the last two decades has meant that rural areas can no longer function as a 'shock-absorber' for unemployment. This is particularly true of the most populous island of Java where the majority of the workforce is now employed in secondary industry and services, with a minority still employed in agriculture. With the introduction of new farming techniques and technology, agricultural productivity has greatly increased, but modernised agriculture frequently employs fewer people than traditional methods. In any case, productivity increases have plateaued in recent years and there are already large numbers of underemployed people (working only a few hours a day or a few months each year) in rural areas. At the best of times there are no prospects for a worker returning to the village, in today's drought there is nothing to offer but hunger. Most unemployed urban workers are forced to eke out an existence in the informal sector (street hawking etc.), depend on family support or seek work in regional towns. The lack of a state system for social support means that official statistics greatly underestimate the problem, but even these calculate unemployment and underemployment to have doubled in recent months to 8.7 million and 18.4 million respectively, figures which represent more than 30 per cent of the workforce.(16)

An End to Affluence, a Return to Poverty

Most industrial workers worked for low wages in poor conditions, but in most cases city jobs represented an improved standard of living over rural semi-employment, especially with the steady increase in wage levels over recent years. Today, however, job losses, falling wages and the spiralling cost of essential commodities have thrown many urban workers back into a struggle for basic existence. For the millions of people drawn into employment in the modern sector of the economy in recent years, the crisis has cut short the promise of being freed from the poverty which had ruled their families' lives for generations.

In rural areas, drought, rice shortages and price increases are also bringing a return to serious and widespread poverty. World Bank estimates suggest that the number of those below the poverty line will increase from 23 million to 40 million.(17) The breakdown of services such as public transport (due to fuel price increases and shortage of imported spare parts) have affected urban and rural areas alike. For the middle class and salaried employees, the crisis has meant a sudden end to the relative affluence which they had begun to accept as normal. Many small business people have been bankrupted or confronted with a drastic decline in business and salaried employees have either lost employment or have had their often fixed salaries eroded by inflation. These groups were also the greatest consumers of imported goods and services and of public goods such as transport, electricity, education and health services, all of which have become much more expensive in the wake of the crisis.

The effects of the economic crisis in Indonesia have clearly been felt differently by different sections of Indonesian society. But the common impact of the crisis has been the shattering of what appeared to most Indonesians to be the promise of improving prosperity. Notwithstanding a number of setbacks in the 1970s and 1980s, stemming mainly from problems in the important oil industry, Indonesia experienced sustained economic growth under the New Order, with an average of about 7 per cent annual growth in the last decade. This growth created unprecedented opportunities for large numbers of Indonesians, with the prospect of continued improvement. The economic crisis, with its inflation, food shortages, widespread bankruptcies and loss of jobs, has threatened to end the recently-acquired affluence of some Indonesians or to bring a return to poverty for many more. The crisis has been a psychological blow to confidence that Indonesia had finally overcome its long history of economic and political instability and was set on a long-term path to prosperity.

The Politics of Crisis-President Soeharto and the New Order

The New Order regime based its legitimacy on a capacity to bring sustained improvements in the standard of living of the mass of Indonesians and to meet the aspirations of an expanding middle class and working class. The apparent end to this success will have grave implications for the political stability of the entire Indonesian state. But even before the onset of the economic crisis, serious pressures were beginning to build up within Indonesia about the lack of progress towards political liberalisation. Many Indonesians were beginning to argue for the development of institutions which might overcome the domination of political life by a small elite around the President and the Army and allow greater mass political participation.

From its very foundation in 1965-66, the New Order has depended for its stability on the leadership of President Soeharto. Soeharto's tenacious grip on the presidency has come to symbolise the personalised nature of New Order politics and the difficulty the regime appears to have in adapting to the changing face of Indonesian society. Paradoxically, the pressure for change has been created by the very success of the New Order in bringing about three decades of economic growth. This development has transformed Indonesia from a country with a tiny social elite and a mass of impoverished peasants to a rapidly urbanising society with new social groups who are gradually becoming less willing to trade political rights for personal prosperity. There is growing resentment about corruption in public life and the domination of economic opportunities by a select few. This is particularly directed against members of President Soeharto's family, most of whom have gained tremendous private wealth from their family connections. With the elevation of the President's daughter to the Cabinet, they appear to be provided with privileged access to political power as well.

There is also a feeling of exasperation that not only does the ageing President Soeharto show no sign of retiring from his post, but he is also unwilling to even discuss the issue of his successor or how a transition of power might take place. Despite the clear current of subterranean discontent, however, there is little indication of moves within elite elements of Indonesian society to remove President Soeharto or to press strongly for reform. The beginnings of unrest in the streets and universities of major cities and regional towns have yet to gain sufficient momentum to be anything resembling a significant challenge to the Government.

President Soeharto and the Army

Given the crucial role of the Armed Forces of Indonesia (ABRI) as the bulwark of the New Order, much recent commentary has focused on the possible actions of ABRI leaders as agents for political change, either to persuade Soeharto to step down or to oust him from power. It is unlikely, however, that ABRI officers would move against Soeharto unless the economic or political situation were to deteriorate drastically. While most observers consider that most of the ABRI leadership think it is time for Soeharto to step down, they are reluctant to express such a view publicly because of their immense respect for Soeharto's achievements as President and because of their close personal relations with him. Members of the current generation of ABRI leaders were trained and rose to prominence under Soeharto and are personally indebted to his patronage. The recently appointed Chief of the Armed Forces, General Wiranto, was a personal adjutant to President Soeharto and rose from the rank of colonel to four-star general in four years. Soeharto's son-in-law, Prabowo, was appointed commander of the elite Strategic Reserve.

Although there have been periods of disagreement between Soeharto and the Army, notably during the late 1980s and early 1990s, Soeharto has since used his power to appoint ABRI officers to ensure that his own supporters hold the key positions. This prerogative was exercised again in February 1998 when he reshuffled the ABRI leadership to strengthen his closest associates. Soeharto has also skilfully manipulated rivalries amongst the top leaders, creating such factional enmities that it would appear to be difficult for many leading ABRI officers to cooperate with each other in any move against the President.(18) In any case, recent thinking amongst many ABRI officers has been influenced by the idea that the Armed Forces should play a less political role and be restructured for external security rather than its traditional role in policing internal stability. Moreover, there is little sign that ABRI leaders have alternatives to the policies being pursued by the President. Most would also be aware that any move by the Army against Soeharto would only weaken international confidence in the Indonesian economy still further.

The Vice-President and the Army

There was widespread concern amongst observers in the international financial community when one of Soeharto's closest confidantes, B. J. Habibie, was made Vice-President. As one of the leading figures associated with the economic nationalist faction of Soeharto's advisers, known for their sponsorship of prestige high-technology projects of questionable economic benefit, Habibie's appointment was interpreted as a sign of Soeharto's unwillingness to reform and regularise Indonesia's economy. But there was also consternation about the appointment within the ranks of ABRI because, according to the Constitution, Habibie would take over as President in the event of Soeharto's death. Habibie's appointment was symptomatic of the relative decline of ABRI influence compared with the situation in 1993 when the Army, against Soeharto's wishes, was able to have its candidate for Vice-President, General Tri Sutrisno, appointed to the office.

Habibie is unpopular amongst the ABRI leadership because he is a rival from a technocratic rather than a military background and because of his sponsorship of the Association of Muslim Intellectuals (ICMI) which, as a mass organisation, gives Habibie a potential political base outside of Army control. ABRI has long been highly suspicious of any mass organisation and ICMI is particularly suspect in ABRI eyes because of its Islamic character. Habibie has also earnt the resentment of many ABRI officers because his organisations have moved into traditional areas of ABRI influence such as defence equipment procurement. Habibie was the main supporter of the purchase of a number of vessels of the former East German navy which most defence professionals considered were inappropriate for Indonesia's strategic requirements.

ABRI's loyalty to Soeharto has ensured that no public criticism of Habibie's appointment has been aired, but it is an open question whether the ABRI leadership would countenance Habibie's assumption of the office of President should Soeharto die or be forced to retire due to ill-health. The possibility that a key institution such as the Army might not accept the person who, in constitutional terms at least, seems most likely to succeed Soeharto underscores the seriousness of the uncertainty surrounding the transition from Soeharto's rule.

Change from Below: A People's Power Movement?

The New Order was born out of the bloody suppression of mass politics, with the killing of an estimated 500 000 people, mostly supporters of the then-powerful Communist Party.(19) Since that time, any expression of popular political will outside officially-sanctioned channels has been vigorously repressed. The dominance of official politics has been challenged on a few occasions, during student riots in 1974, Muslim riots in Jakarta in 1984, workers' riots in Sumatra in 1984 and by the clashes which followed the takeover of the headquarters of the Indonesian Democratic Party (PDI) in July 1996, but these never amounted to a real challenge to the status quo. Similarly, regional secessionist movements in East Timor, Aceh and Irian Jaya have been largely contained. There have been periods during which the Government appeared to be loosening political control, particularly during the period of 'openness' in the early 1990s, but these have always been followed by a renewed crackdown on free public expression and independent political activity. The closure of the newsmagazine,Tempo, and the ousting of Megawati Sukarnoputri from the leadership of the PDI (one of the three officially-sanctioned parties) in 1996 shattered any illusions that President Soeharto was willing to allow movement towards democratisation. A leading dissident academic, Ikrar Musabhakti, was recently quoted as saying:

Our openness is like a rubber ring. It can be opened quite wide sometimes, but the Government can also close it very quickly if it becomes dangerous.(20)

The current economic crisis and its attendant social effects have, however, raised the possibility that many ordinary Indonesian people may join in spontaneous or organised movements of protest which turn out to have a major impact on the course of Indonesian politics. There have been riots in a number of regional towns in Indonesia, particularly in the period following the major price increases of January 1998. Many of these riots were directed against ethnic Chinese-owned businesses. Ethnic Chinese make up less than 3 per cent of Indonesia's population, but are said to control 70 per cent of private business activity.(21) Tight control by ABRI in large urban areas has, however, kept the riots limited in extent. There have also been a number of apparently middle class protests in cities such as Jakarta, but these have also been easily contained by the security apparatus.(22)

It could be argued that the most important development has been the rise of student demonstrations calling for democratisation and the end of President Soeharto's rule. To date, however, riot police have prevented the students from taking extending their movement outside the campuses or from joining together with protests organised by middle class or labour organisations. Nevertheless, the situation on many campuses remains volatile and recent reports of the disappearance of students after being beaten and arrested by police can only serve to intensify feelings. An increase in reports of human rights abuses will also focus international criticism on the Indonesian Government.(23)

There may be limits to the extent to which the security forces are able (or willing) to maintain control over popular protest, especially if the economic situation continues to deteriorate. Urbanisation and other changes in Indonesian society have meant that there are now many more people who could be drawn into a mass movement than might have been the case even a decade ago. Recent years have seen the growth of a large number of non-government organisations (NGOs) committed to social and political change and the emergence of independent labour unions and farmers' organisations. Many middle class people have also been drawn into mass Islamic cultural organisations such as Nahdlatul Ulama (NU) and Muhammadhiya. Megawati Sukarnoputri (daughter of the famed leader of the Indonesian independence movement, Sukarno) has, since her ouster from the PDI, arisen as something of a symbol of opposition to what many see as a repressive system.

Some analysts have discussed the possibility of the emergence of some kind of 'people's power' movement in Indonesia, along the lines of the movement responsible for the downfall of President Marcos in the Philippines in 1986. The situation also has parallels with the circumstances prevailing before the overthrow of the Shah of Iran in 1979, in that a development-oriented, economically successful regime created an urbanised, increasingly politicised society which lost patience with its government's capacity to guarantee prosperity or create space for political dissent. One scenario could be a loose alliance between Abdulrahman Wahid (leader of NU), Megawati and Amien Rais (leader of Muhammadhiya) in a campaign to induce Soeharto to step down or for wider political reform. Such a movement would certainly be supported by the NGO sector and independent labour organisations, but NU and Muhammadhiya have traditionally eschewed oppositional politics in favour of religious and social service. Relations between Rais and Wahid have also been strained over a range of differences. Megawati has not yet shown herself to be prepared to lead a major confrontation with the Government. Notwithstanding signs of popular politicisation in recent years, civil society in Indonesia has been stultified for three decades under the New Order and there does not yet appear to be the beginnings of significant organised opposition.

Once again, a great deal will depend on the actions of the Armed Forces. If large scale rioting were to break out in major cities and required a heavy armed response to quell, the prospect of having to shoot people in the streets of Jakarta might cause existing divisions within the ABRI leadership to develop into an open split. The official ABRI position is that it is the protector of the Indonesian state and not any existing government, a doctrine which might make some officers recoil from a violent crackdown if sufficient numbers of Indonesians were to take to the streets. Such an eventuality would precipitate a political crisis threatening the very existence of the New Order. For the moment, however, there are no signs that the current situation has created such pressures within ABRI or that it is having any difficulty in controlling riots or demonstrations. But the fact that such possibilities are even under discussion is an indication of the potential for serious instability and conflict inherent in the situation in Indonesia today.

The Implications for Australia

From Weakness to Strength: Indonesia-Australia Relations

Relations between Australia and Indonesia since the declaration of an independent Indonesian state in 1945 have had a rocky history, with periods of good relations broken by sometimes open animosity. An initial period of warmth prevailed immediately after independence because of the Australian Government's support for Indonesia's independence struggle. The relationship soured following the change of government in Australia in 1949 and reached a low point in the early 1960s over the issue of Indonesia's claim on the Dutch-held western half of the island of New Guinea (now Irian Jaya) and over Indonesia's campaign of 'confrontation' against Malaysia. Until the late 1980s, relations were dominated by political and security issues in Southeast Asia played out against the background of the Cold War. The tension which characterised relations during the rule of Indonesia's first President, Sukarno, disappeared with Soeharto's rise to power, but the relationship was marked by a series of problems. The most prominent of these were associated with the invasion of East Timor in 1975 (especially the killing of five Australia-based journalists) and the negative Indonesian response to aSydney Morning Herald article in 1986 detailing the business affairs of President Soeharto. Popular perceptions reflected the mutual ignorance of two neighbouring but very different societies, with most Indonesians hardly aware of Australia's existence and many Australians regarding Indonesia with fear and suspicion.(24)

Since the late 1980s, however, the efforts of the Australian Government, accompanied by Australia's generally increasing economic involvement in the region have facilitated the broadening and deepening of the Indonesia-Australia relationship. These efforts coincided well with the Indonesian Government's desire to move its foreign relations beyond a predominant focus on ASEAN. The predominance of politico-strategic issues has been replaced by a broader range of trade and investment relations and greater people-to-people links in the form of two-way tourism, Indonesian students in Australia (in 1997 Indonesia was the second-largest source of overseas students) and the slow development of non-official as well as government-sponsored cultural exchange. Australia and Indonesia are now also part of a network of regional relationships through their common membership of organisations such as APEC and the ASEAN Regional Forum.(25)

Until the mid-1980s trade between Australia and Indonesia was insignificant. Since 1985, however, bilateral trade has grown at an average rate of 19 per cent per year and Australia is now Indonesia's sixth largest trading partner and Indonesia is Australia's tenth most important partner. Bilateral trade reached almost $5 billion in 1996. Accumulated Australian investment in Indonesia has been calculated to be in the vicinity of $US6 billion in 1997.(26) The strengthening of the official bilateral relationship was affirmed by the signing of the Timor Gap Treaty in 1995 and the Maritime Boundary Treaty in 1997, a relationship underpinned by regular meetings at ministerial and official level between the two governments. The signing of the Indonesia-Australia Agreement on Security at the end of 1995 formalised the already well-developed defence and security ties between the two countries, although the mixed public reaction to the Agreement symbolised continued popular uneasiness in Australia about Indonesia.(27)

As one of Australia's closest neighbours, the political and economic fate of Indonesia was always going to be of direct relevance for Australia.(28) This underlying reality has become even more obvious, given the rapid expansion in the links between Australia and Indonesia over the last decade. Indonesia's economic problems have meant a sudden drying up of opportunities for the growing number of Australian businesses operating in Indonesia and the growth in trade is likely to slump and may even register an absolute decrease over the next year or so. Inbound tourism has already been affected and the number of Indonesians studying in Australia is certain to decrease. Like the overall effects of the economic crisis in East and Southeast Asia, the impact on Australia's trade in commodities and services and on investment flows with Indonesia is still yet to be quantified.

Australia and the Region

There is no doubt, however, that the Australian Government needs to be concerned about potential dangers in a deepening political crisis in Indonesia. As the largest country in ASEAN, Indonesia is a key strategic player in the region and has been important in developing positions to manage issues amongst the ASEAN countries and in developing a common ASEAN position on relations with China, including reducing tensions over regional territorial disputes involving China. Resolving such issues has been a crucial element in the evolution of security arrangements in the Asia-Pacific since the end of the Cold War.

Political uncertainty in Indonesia, especially if it involved open conflict over the succession from President Soeharto, would throw many of these achievements into doubt. Any perception on the part of the Chinese Government that the Indonesian Government was fostering or allowing animosity towards the ethnic Chinese minority in Indonesia, for example, could adversely affect relations with China. Tensions have emerged between Malaysia and Indonesia over the issue of Indonesian migrant labourers in Malaysia who have come under pressure to leave because of Malaysia's economic problems. There have also been hints of concern from other members of ASEAN over Indonesia's unwillingness to take difficult decisions to reform its economy and thus find a solution to economic problems which threaten to damage the whole region.(29) Invidious comparisons have been made with Malaysia and Thailand's ability to deal with its problems more effectively. There have already been disagreements between the US and Indonesian Governments in recent years over issues of human rights and labour rights and the suppression of political protest in Indonesia is likely to focus greater critical US attention on developments inside Indonesia.

Australia has an interest in minimising such tensions and conflicts because of its general interest in stability in the Asia-Pacific region and because of its direct bilateral relationship with Indonesia. In bilateral terms, of particular concern in press and public perception is the possibility that economic problems in Indonesia might lead to the arrival of Indonesian refugees or illegal migrants on Australia's shores. Any problem of this type is more likely to manifest itself as wealthy ethnic Chinese Indonesians arriving at Perth or Sydney airport than the stereotype of impoverished 'boat people' in Darwin harbour, but given sensitivity on this issue within Australia, the Australian Government will need to monitor the situation closely.

Australia's Response

The Australian Government's response to the Indonesian crisis has been to provide direct emergency assistance to Indonesia and to contribute, both financially and at a policy level, to the IMF program of assistance. Since October 1997, the Government has provided $8.8 million to a number of programs designed to help relieve problems created by the drought, increasing food prices and unemployment, particularly in the worst affected areas of eastern Indonesia. Australian officials and advisers have also been working with Indonesian agencies to develop strategies to create employment in affected areas. In order to provide a 'second line' of financial support for the Indonesian currency should the IMF finance be insufficient to stabilise the rupiah, the Australian Government made available a loan of $US1 billion, as a part of contributions from a number of regional countries totalling $US17 billion.(30) The Government has stated that the loan is conditional on fulfilment of the terms of the IMF reform package.

While supporting the conditions of the IMF package, the Australian Government has taken the view that the implementation of reforms should be spread over a number of years, thus enabling the second postponed tranche of the loan to be delivered with less onerous conditions attached. In March 1998, the Minister for Foreign Affairs, Mr Downer, visited the US and Japan to hold talks with US and Japanese Government representatives and officials of the IMF and World Bank with the objective of helping to facilitate an agreement between the IMF and Indonesia. The US Government took a similar position to Australia (notwithstanding some controversy within Congress) and, despite some opposition reportedly expressed by some countries of the European Union, the IMF Managing Director, Michel Camdessus, has moved towards support for such a position.(31) This has been the basis for the discussions taking place between Indonesia and the IMF at the time of writing. Australia has also been a party to World Bank talks regarding the delivery of humanitarian assistance to Indonesia to help deal with the problem of shortages of food and other essentials in the coming year.(32)


The economic and political crisis in Indonesia had its genesis outside the country and did not at first appear to present major difficulties for a country whose macroeconomic management was reputed to be generally sound. Once the uncertainty about many Asian currencies began to affect Indonesia, however, the major structural problems in the country's financial sector and the real level of its private foreign debt became obvious and took the rupiah to levels far below those of other falling currencies in the region. Although the current exchange rate is generally regarded to vastly exaggerate the real problems of the Indonesian economy, the rupiah has not yet recovered because the Government's response to the crisis has only served to undermine international confidence in the currency. The lack of confidence also reflects deep-seated fears about the political future of Indonesia, with an aging President who insists on retaining power and obstructing political change even while he appears increasingly out of touch with international economic realities and with the feelings of many of his own people.

At the time of writing it now appears that the Indonesian Government and the IMF are inching towards an agreement which would allow the recommencement of a flow of essential financial assistance to the Indonesian economy. Without that assistance Indonesia would be unlikely to be able to stabilise its currency, which is essential as the first step to restoring the viability of its financial sector and returning Indonesian companies to solvency. Only then will Indonesia be able to take advantage of the opportunities offered by a devalued but stable currency in terms of improved export competitiveness and attractiveness to foreign investors.

In the meantime, however, the social effects of the crisis continue to bite into the living standards of the Indonesian people, with millions of people losing their jobs and every Indonesian suffering as a result of the spiralling cost of basic consumer items. Estimates of the numbers of people being thrown back below the poverty line represent a tragic reversal of the steady progress which Indonesia had been making over the last decades in liberating its people from generations of poverty. The worsening effects of the crisis on the daily lives of ordinary Indonesians threatens to bring the already growing political dissatisfaction amongst many people into the open, whatever their fears about Army repression.

The New Order has prevailed for thirty years because it brought prosperity to most Indonesians, while relying on ABRI to suppress any voices of dissent. In doing so it both heightened expectations and fostered resentment because economic development was matched by political liberalisation. The current crisis has shattered expectations and brought to the surface subterranean discontent which has long been felt about President Soeharto's blatant favouritism and his refusal to allow any public criticism or protest. The transformation of Indonesian society brought about by the New Order has created new potential players clamouring for a say about the new political realities of Indonesia. There are also millions of jobless and underemployed people in the cities and towns of Indonesia. Despite the absence of any obvious individual or movement to lead them today, it is not inconceivable that they might join into a mass movement that, as in the Philippines in 1986 or in Iran in 1979, brings down a governing order.


  1. Phil Hanratty,Economic and Financial Turmoil in South-East Asia: Origins and Consequences, Parliamentary Library Information and Research Services, Current Issues Brief No. 8, 1997-98.

  2. Leif Roderick Rosenberger, 'Southeast Asia's Currency Crisis: A Diagnosis and Prescription',Contemporary Southeast Asia, vol. 19, no. 3, December 1997, p. 225.

  3. ibid., pp. 225-26.

  4. ibid., pp. 228-232

  5. ibid., pp. 236-38.

  6. Oxford Analytica Daily Brief, 28 November 1997.

  7. Economist Intelligence Unit,Indonesia Country Report, 3rd Quarter 1997, pp.22-23.

  8. Ibid., pp. 19-21.

  9. Rosenberger, op. cit., p. 243.

  10. Statement by the Managing Director on the IMF Program with Indonesia, International Monetary Fund News Brief No. 98/2, 15 January 1998.

  11. Sydney Morning Herald, 8 November 1997, Oxford Analytica Daily Brief, 28 November 1997.

  12. International Monetary Fund News Brief No. 98/2, 15 January 1998.

  13. Canberra Times, 19 March 1998, p. 7.

  14. Asiaweek, 13 March 1998, p.26. Oxford Analytica Daily Brief, 14 January 1998.

  15. Oxford Analytica Daily Brief, 14 January 1998.

  16. The Australian, 27 March 1998, p. 7.Sydney Morning Herald, 1 April 1998, p. 11.

  17. The Australian, 27 March 1998, p. 7. Oxford Analytica Daily Brief, 14 January 1998.

  18. I am grateful to Dr Harold Crouch of the Australian National University for much of the analysis in these sections. See Harold Crouch,The Army and Politics in Indonesia, Ithaca, 1978, for a comprehensive study of ABRI's political role. See also Joshua Frydenberg,The Australian, 17 February 1998, p.13.

  19. For an account of the violence of 1965-66 see Crouch,op. cit, pp. 221-244.

  20. Canberra Times, 1 April 1998, p. 11.

  21. Sydney Morning Herald, 21 February 1998, p.38.

  22. See for example the report of a protest about price rises by a group called 'The Voice of Concerned Mothers' in Jakarta on 23 February 1998.Canberra Times, 24 February 1998, p.6.

  23. Sydney Morning Herald, 6 April 1998, p.8, 7 April 1998, p.8.Canberra Times, 7 April 1998, p.8.

  24. For a survey of some Australians' views about Indonesia, see Rob Goodfellow, 'Ignorant and Hostile: Australian Perceptions of Indonesia',Inside Indonesia, September 1993, pp. 4-6.

  25. For a survey of Australia-Indonesia relations see B. Bishop & D. McNamara (eds.),The Australia-Asia Survey 1997-98, Melbourne, 1997, pp. 183-211 and Dept of Foreign Affairs and Trade,Country Economic Brief: Indonesia, Canberra, 1997.

  26. Dept of Foreign Affairs and Trade,Country Economic Brief: Indonesia, Canberra, 1997.

  27. For a discussion of issues surrounding the Security Agreement see Gary Brown, Frank Frost and Stephen Sherlock,The Australia-Indonesia Security Agreement: Issues and Implications, Parliamentary Research Service, Research Paper No. 25, 1995-96.

  28. For a discussion of the debate about policy options open to the Australian Government when responding to political conflict and change in Indonesia see Stephen Sherlock,The Politics of Change in Indonesia: Challenges for Australia, Parliamentary Research Service Current Issues Brief No. 3, 1996-97, pp.6-10.

  29. Asian Wall Street Journal, 27 February 1998.

  30. Data supplied by the Australian Agency for International Development (AusAID).

  31. The Australian, 25 March 1998, p. 9.Weekend Australian, 4 April 1998, p.7.

  32. Australian Financial Review, 2 April 1998, p. 12.

Appendix: Australia's Trade with Indonesia

Appendix: Australia's Trade with Indonesia