Something very important is happening in Southeast Asia, but its
significance has yet to register fully in America. Indonesia, the
Brazil of Southeast Asia, is in very deep trouble. It has often been
said that, as the world's fourth-largest country, Indonesia is the
important country America least understands. The last time the United
States paid serious attention to it was in the mid-1960s when, as the
Cold War gripped Southeast Asia, Indonesia came very close to
imploding. For roughly a quarter century after that, the country was
a low profile economic success story, and the anchor of regional
stability in Southeast Asia.

This year Indonesia has been thrown into a very deep crisis. Having
made truly extraordinary economic progress and become a model of
developmental rectitude for the World Bank, it is now experiencing
economic devastation. Indonesia's economy has yet to bottom out, and
the task of rehabilitation will be very difficult. To compound its
problems, Indonesia is now also having to grapple with the task of
constructing a new political system following the collapse of the
deeply entrenched authoritarian regime of the long-serving strongman,
Suharto. The country's political life is today changing rapidly, with
the rise of a politicized Islam and other groupings in preparation
for the expected reworking of the country's political framework.

There is much at stake in Indonesia today. If the economy is laid low
for a long period, not only will there be major human suffering but
democracy will have little chance of taking hold. The ensuing
troubles would affect the well-being of Southeast Asia more
generally. Indonesia stands at a threshold: this could be a
transitional point at which its political and economic institutions
mature, or it could just as easily slide backwards into a truly
frightening abyss. How the United States responds to Indonesia's
current crisis may well have long-lasting consequences. It is time
for America to start paying serious attention again.

From Bust to Boom

Before turning to the questions of what has gone wrong in Indonesia
and where the country is now headed, some history. Suharto's
so-called New Order regime was born amidst economic and political
chaos even greater than that which now grips the country. Under the
erratic socialist-style economic management of his predecessor,
Sukarno, the economy limped through the early 1960s before suffering
a complete breakdown in 1965 as hyperinflation spiraled out of
control. Intertwined with the country's worsening economic plight
were mounting tensions between the very large and active Indonesian
Communist Party on the Left, and the army together with Muslim groups
on the Right.

The spark that finally set this combustible situation ablaze was an
abortive coup attempt by disaffected military officers at the
beginning of October 1965. In the ensuing confusion, Sukarno was
discredited and pushed aside as Major General Suharto moved to put
down the coup, link it to the Communist Party, and assume increasing
control of government. What followed was a year of bloody chaos and a
fundamental realignment of national politics. As the pendulum swung
from left to right, the Communist Party was outlawed and a tidal wave
of killing swept the country, with somewhere between one hundred
thousand and one million Indonesians slaughtered in an uncontrolled
anti-communist pogrom.

Backed by the military and, initially at least, a broad coalition of
civilians, Suharto vowed to re-establish order and to revive the
economy. This he certainly did. On the economic front he and his
advisers engineered a dramatic re-orientation. A stiff stabilization
program was put in place and accompanied by a range of measures to
open the economy. In return, a large consortium of creditors
comprising the IMF, the World Bank, the United States, and an array
of other industrial countries agreed to extend Indonesia large-scale
financial assistance. This proved to be one of the most successful
emergency stabilization efforts ever attempted in the developing
world. Hyperinflationwas quickly brought under control, local
Indonesian Chinese investors returned, and foreign capital began to
flow in (primarily U.S. oil and mining companies and Japanese
manufacturers). Indonesia's economy started to pick up very quickly.

Indonesia was also a beneficiary of the OPEC-led oil price
revolution. Inevitably, a substantial portion of this bonanza was
squandered or pilfered. More remarkable, however, was the fact that
some of it was well used. By comparison with most other oil-rich
developing countries, Indonesia was able to contain macroeconomic
distortions and to ensure that a decent share of the revenue was
invested in public education, health systems, and other public
infrastructure. One notable by-product of the oil boom was that it
reduced the country's dependence on foreign capital and encouraged a
resurgence of economic nationalism. Although less open to the global
economy, Indonesia continued to grow very rapidly through the 1970s
on the basis of domestically oriented manufacturing and service
industries and natural resource exports.

Most of the firms that prospered during this period were controlled
by Chinese Indonesians. A small minority (3-5 percent of the
population) and long subject to popular resentment, Chinese
Indonesian business people typically got ahead by hitching their
fortunes to the most influential bureaucrat or military officer they
could afford, exchanging economic favors for preferential treatment
and political protection. The more powerful and enduring the patron,
the more successful the firm.

But not all the main economic action was taking place in the
corporate sector; also critical during this first decade of rapid
growth were the truly remarkable gains made in rice productivity.
Where Indonesia had struggled to feed itself and had hitherto been
the world's biggest importer of rice, by the early 1980s
self-sufficiency in rice had been achieved.

Indonesia's economic success story underwent a fundamental change in
the mid-1980s when the country was hit by a severe balance of
payments crisis as a result of collapsing oil prices and the
realignment of the dollar-yen relationship. In a radical
restructuring exercise, the government moved to deregulate the
financial sector and cut back the plethora of trade and investment
restrictions that had accumulated through the oil-boom years and
which prevented Indonesia from being internationally competitive.
These reforms, together with a flood of foreign capital from Japan,
Korea, and Taiwan in the late 1980s, saw Indonesia shift to a much
more export-oriented footing as labor-intensive manufactures began to
take off and surpass traditional natural resource exports. Indonesia
was away on the next phase of its economic success story, which
continued unabated until the crash of 1997-98.

Fundamental change occurred in the political sphere as well, though
this produced international criticism rather than acclaim. The swing
to authoritarian politics in Indonesia actually began as far back as
1957, when Sukarno and the army declared martial law to end the
fledgling republic's short and messy experiment with parliamentary
democracy. However, it was under Suharto's New Order that a stable
and systematic pattern of authoritarian rule evolved. Having
eliminated the Left, Suharto moved to consolidate his grip on the
armed forces and the bureaucracy. Military officers were placed in
oversight positions throughout the national bureaucracy and through
sub-national official structures, reaching right down to the village
level.

Along with tightening its grip on the state apparatus, the government
worked to limit and control autonomous political activity within
Indonesian society. Political parties were emasculated and became
pliant instruments of the government. Interest groups were co-opted
in a vast yet indolent corporatist network organized beneath the
umbrella of the state political party, golkar. While the electoral
process was not subject to gross fraud or machine guns at the ballot
box, it was nonetheless a carefully choreographed exercisethat was
systematically weighted in golkar's favor. As this system of
political control and demobilization solidified, and with the economy
continuing to boom, the position of the president became both secure
and all-powerful. Every five years he was elected unopposed by the
Peoples' Consultative Assembly, a tame body comprising the House of
Representatives and an equal number of appointees.

Employing both carrots and sticks, Suharto's New Order regime
functioned smoothly for a remarkably long time. The great majority of
the population enjoyed impressive economic advancement, with people
in positions of importance--especially key supporters--having
opportunities to capture great wealth. Still, when faced with acts of
political defiance or organized dissent--whether from alienated and
pious Muslims or angry and UNCO-opted labor activists--security
forces did not hesitate to crush opponents.

Within Indonesia, the primary complaints against the regime centered
on political restrictions and corruption. Internationally, the focus
of political criticism centered not so much on mainstream political
dissent as on human rights abuses in the treatment of separatist
movements in two provinces on the eastern fringe of the archipelago:
Irian Jaya and East Timor. Both territories were incorporated into
the republic under the New Order. Irian Jaya became part of Indonesia
as a result of a dubious self-determination exercise in 1969 after
being prized loose from the Dutch with U.S. support. East Timor was
annexed militarily by Indonesia in 1976, following Portugal's
abandonment of its former colony and the outbreak of civil war there.

The resistance to Indonesian rule has been stronger in East Timor,
with the Free Papua Movement in Irian Jaya being a much smaller and
more divided grouping than Fretilin, its counterpart in East Timor.
In addition to pumping large sums of money into East Timor, Indonesia
has relied heavily on its armed forces to overcome the opposition.
This strategy has been a failure. Along with a very high death toll,
demands for independence in East Timor have continued unabated and
Jakarta has had to endure constant international condemnation in the
name of a cause that commands little public support elsewhere in the
country. With Indonesia in deep economic crisis and political flux,
and another upsurge of separatist activity in East Timor now
underway, there is a real possibility that the military's
determination to keep East Timor as part of the Republic will
dissipate, clearing the way for a separation. Ironically, while this
would eliminate a major problem for Indonesia, it would be unlikely
to bring calm to East Timor.

. . . And From Boom to Bust

Between 1966 and 1996 Indonesia's economy grew on average by nearly 7
percent annually. In the first half of 1998 alone, its economy has
contracted by an estimated 12 percent, which, according to the
Financial Times, is the most dramatic economic contraction anywhere
in the postwar era. Indonesia's economy is now a smoldering wreck.
What went wrong? How could this be the fate of a country that was
held up as a model by the World Bank?

Recently it has been suggested that the Word Bank was wrong to tout
Indonesia as a model of success; that some dimensions of its economic
"miracle" were in fact fake; that the Bank was guilty of knowingly
endorsing inflated economic statistics to put Indonesia's record in a
better light; and that its operations in Indonesia were afflicted
with corruption (Wall Street Journal, July 14, 1998). There is
certainly some truth to these and kindred claims. The World Bank was
in an overly cozy relationship with Indonesia, there were real
problems of corruption in Bank projects, some of the statistics were
dubious, and some of the reporting was hyped. But the brouhaha about
Bank operations, its internal contradictions, and the way in which it
deals with its largest clients obscures what is, for present
purposes, a much more important point: even allowing for some fudging
of statistics (and where in the developing world has this not happened?),
Indonesia made stunning economic progress on many fronts. No serious
observer of the country would deny this. Of course there were
always real problem areas--again, where in the developing world were
there not?--but the larger truth is no less for this. Indeed, were
this not to be the case, then what is happening in Indonesia today
would not be universally regarded as an astonishing economic reversal.

Why then has Indonesia been so afflicted? Indonesia's currency
collapse has little to do with the World Bank. Clearly it was swept
up in the region-wide economic crisis that afflicted all of the open
Asian economies. And there can be no doubt that Indonesia, like a
number of other countries in the region, suffered from some notable
areas of policy weakness. But there was no necessary economic reason
that it should have suffered a reversal of fortunes so devastating.
Fundamentally, Indonesia's problem was a sudden loss of confidence on
the part of local and foreign investors which, as in Thailand and
South Korea, was a function of investor calculations about the
likelihood of the government of the day dealing effectively with the
problems at hand. In short, once the crisis got underway, investors
were making calculations about political circumstances as much as
economic circumstances. Although Thailand, South Korea, and Indonesia
all had serious political problems, Indonesia's became the most
dysfunctional and the most corrosive to investor confidence.

It is worth recalling that things did not appear this way during the
early months of the crisis. Where the Thai central bank spent an
estimated $23 billion of reserves defending the exchange rate,
hesitated in going to the IMF, and then had difficulty implementing
the program negotiated, Indonesia behaved quite differently. Before
the rupiah even came under serious speculative attack, the government
moved to widen the band within which the currency traded as a
pre-emptive measure. As the crisis intensified regionally, the
authorities cut the rupiah completely free, drove up interest rates,
scrapped foreign ownership limits on the stock exchange, reduced
tariffs, and froze a range of high-cost infrastructure projects. In
short, the Indonesian government moved quickly to contain the crisis,
and won praise in the financial community for doing so.

In this, the government's response was in keeping with its response
to past economic crises: swift, decisive, and effective action.
Unlike his Thai counterpart, Chavalit Yongchaiyuth, Suharto was able
to move so decisively because power within Indonesia's political
system was highly centralized. But a political system of this sort
also entails real economic risks, for if the leadership begins to
behave in ways that are damaging to investor confidence, there are no
institutional checks or balances to constrain it.

For many years investors found Indonesia attractive because of the
high rates of return to be had there, the regime's track record of
sound macroeconomic management, and the fact that they could always
get their money out easily (Indonesia has had an open capital account
since 1970). As 1998 began, however, these assurances were being
swept away. In early December Suharto suffered a stroke, triggering
serious doubt about his future and intensifying long-standing
uncertainty about the process of political succession. There was a
growing sense of doubt concerning Suharto's commitment to economic
reform. With members of his family and other crony business
associates making clear that they would not be subject to any
unwelcome restructuring measures promised by the government, economic
leadership appeared increasingly rudderless. Combined, these factors
pushed the rupiah down very sharply through December. Then in early
January of this year the government unveiled a budget that was widely
interpreted as being out of touch with economic reality. Investors
dumped the rupiah in a massive sell-off and panic set in among the
urban middle class, with supermarkets being emptied of essential
foodstuffs and supplies. At this point Suharto's economic credibility
was terminally damaged.

What followed was the slow but inevitable slide of the regime toward
destruction. With local and foreign investors no longer willing to
trust the government, there was no market demand to lift the
currency, and with the currency at a small fraction of its former
value (between 8,000-16,000 to the dollar compared to 2,500 prior to
the crisis) it was merely a matter of time before the collapsing
economy forced political change. This eventually came on May 21 when,
after mounting student demonstrations, seriously destructive rioting
and looting in Jakarta, and finally rapid elite defection, Suharto
stepped down. The New Order was over.

An important question in Indonesia's economic disaster concerns the
role of the IMF. An impressive array of people--ranging from leading
mainstream economists through prominent economic revisionists, and on
to nationalists and Muslim radicals of various sorts in
Indonesia--argues that the IMF bears heavy responsibility for
Indonesia's economic woes. The specific charges vary, but include: a
narrow ideological insistence on a fiscally austere one-size-fits-all
approach, a misguided focus on structural reform at the expense of
greater attention to the debt problem or the exchange rate itself, an
ill-advised requirement that sixteen weak banks be closed (which
triggered a run on some other banks), and the claim that the IMF
(presumably at Washington's behest) was really out to get Suharto and
ensured his demise through very high-level leaks that jaundiced the
market's reception of the January budget.

This is a diverse set of charges and opinions concerning their
validity vary widely. But even admirers of the IMF would probably
have to agree that its interventions in Indonesia from September 1997
through May 1998 were, at best, of uncertain benefit. But while these
interventions did little to make things better, it is a mistake to
lay the blame for Indonesia's economic catastrophe at the doorstep of
the IMF. Like the World Bank, the IMF is given too much credit by
both its enthusiasts and its tormentors. The real culprit was the
Indonesian government's own awful mishandling of the crisis from late
1997 onwards, and this mishandling was ultimately rooted in the
country's extraordinarily centralized political system. The same
political system that had facilitated the decisive handling of early
economic crises spelled disaster once the leader was perceived as
unwilling or unable to provide effective economic leadership. Any
sins of omission or commission by the IMF--and no doubt there are at
least some--fade into the background compared to the devastating
consequences for investor confidence of an unconstrained, aging,
ailing, and increasingly erratic autocrat.

The Road Ahead

In simplified terms, Indonesia now faces two daunting and intertwined
tasks: it must construct a new political framework that is workable,
and it must stabilize and then rebuild its economy.

Because Suharto so dominated the old regime, his departure has
removed the country's principal power referent. As a result, all the
people in key positions today--President Habibie, armed forces
commander Wiranto, and the various members of cabinet--are struggling
to find their own political feet and develop their own power bases.
All rose to influence on the basis of Suharto's support and all did
his bidding; now they must reinvent themselves politically if they
are to survive. To this end, Habibie has moved quickly to distance
himself from Suharto's regime by lifting controls on the press,
political parties, and labor unions. He has freed a range of
political prisoners and promised to present a set of major political
reforms for approval of the Peoples' Consultative Assembly by
November 10, so that fresh and genuinely democratic elections can be
held in 1999. Under the old New Order there was little room for
genuinely independent social organizations. Now, suddenly, civil
society is blossoming, with new organizations and movements popping
up each day--ranging from political parties, through labor unions, to
student action groups and voluntary associations to help Chinese and
other victims of the looting and raping that took place in the final
days of the old regime.

Given the great flux in Indonesian politics, there is much that
remains uncertain. Nonetheless, the broad outlines of what are likely
to be the major political groupings in post-Suharto Indonesia are
emerging. Four such groupings stand out. The first is modernist
Islam, which has as its institutional focus the Muhammadiyah--a large
and sprawling social welfare organization, estimated to have some
twenty-eight million members. Its core base of support is among civil
servants, professionals, and traders in urban centers. Politically,
it stretches from hard-core puritan groups such as Dewan Dakwah,
through pragmatists such as its current leader, Amien Rais, and the
country's new president, Habibie, and on to liberal-leaning Islamic
intellectuals like Nurcholish Madjid.

A second distinct political constituency is traditional Islam
centering on the Nahdatul Ulama (NU). The NU is a large social and
education movement (with an estimated thirty million supporters)
built around traditional religious teachers. Where supporters of
Muhammadiyah tend to be urban-based and better educated, the
traditional stronghold of the NU has been in rural villages,
particularly in East Java. Where the modernist wing of Indonesian
Islam emphasizes piety, puritanism, and in the past was associated
strongly with the push for an Islamic state, the traditional wing,
especially under the leadership of the NU's wily Abdurahman Wahid,
has emphasized tolerance, inclusion, and preservation of the status
quo.

A third major political grouping is likely to be built around what
might be termed secular nationalists. As with the two Islamic
political clusters, this one has roots in the pre-Suharto era.
Secular nationalism was the political vein tapped by Sukarno in the
1940s and 1950s, and today it is embodied in the leadership of his
daughter, the opposition political figure Megawati Sukarnoputri. As
with the two large Islamic political clusters, the party vehicle for
Megawati to pursue this constituency remains to be determined. One
possibility, widely mooted among liberals in Indonesia, is that
Megawati might join forces with Abdurahman Wahid of the NU in a
"Rainbow Coalition."

The final large constituency in the political life of the new
Indonesia is likely to center on the former state political party,
golkar. It has been widely discredited in the wake of Suharto's fall
and has been deserted by a number of its component parts. The armed
forces leadership has declared publicly that it will draw back from
golkar and no longer bias the political environment in its favor. In
spite of these setbacks, a number of professional politicians who are
mostly secular Muslims with pro-reform orientations have been willing
to work with and through Habibie in order to gain control of golkar
and turn it to their purposes. The most prominent figure in this
group is Akbar Tandjung, the new chairman of golkar, who also
occupies the powerful position of state secretary in Habibie's
cabinet. Although laboring under heavy stigma as a creature of the
Suharto regime, golkar has a number of factors in its favor. First,
its members currently constitute a majority in both the House of
Representatives and the Peoples' Consultative Assembly. Second, it
has a well-developed party structure reaching down to the provincial,
district, and village levels. Third, it will probably benefit
financially from both the state enterprise sector and the many
frightened Chinese Indonesian business people who have nowhere else
to turn.

There are likely to be other political parties representing smaller
constituencies such as radical Islamic groups, Christians, and labor.
Critical to the fortunes of both major and aspiring minor political
parties--and, more broadly, to the prospects of democratic politics
in Indonesia--will be the political rules currently being drafted as
part of the process of political reform promised by Habibie. To have
any chance of success, the new institutional framework will need to
satisfy three fundamental political needs.

First, it will need to respond effectively to the clear public
rejection of the old authoritarian regime by providing for real
checks on the presidency, greater accountability, and better
representation. Second, however, it will need to satisfy the core
interests of the military, which, although long in the shadow of
Suharto, remains the most potent political force in Indonesia by a
very long margin. The military leadership will want to see caution in
the reform process, so that neither national stability nor its own
political interests are jeopardized. In particular, it will want to
ensure its own continued involvement in the governing of the country.
Third, the new framework will also need to satisfy the interests of
key politicians: Habibie and the golkar leadership, Amien Rais,
Abdurahman Wahid, and Megawati Sukarnoputri. All will want a system
favorable to large parties. golkar will be critical, for it still
dominates the House and the Assembly and will thus control the
approval of the new rules. However, if the three principal non-golkar
political leaders were united in opposing any proposed new framework,
it would probably be stillborn.

As of mid-August, a remarkable level of tacit consensus seems to have
evolved. Two official political reform working parties (one under the
Interior Ministry, the other under the Justice Ministry) appear to
have converged around a peculiar hybrid framework. The power of the
presidency is to be circumscribed by a two-term limit and, more
importantly, by enabling the legislature to function as a real
institutional check by virtue of freeing the political parties from
the various shackles imposed on them under the New Order. The
electoral system will feature both single member districts decided on
a plurality basis and nationwide seats decided on a proportional
representation (pr) basis, but with a heavy weighting toward the
former. If elections are indeed free, the tendency should be toward a
few large parties dominating the legislature, though the small number
of pr seats seems designed to provide some representation for
minority constituencies. Under the mooted framework, the armed forces
will be guaranteed 50 seats in the 500-seat legislature (down from 75
under the old system).

If the reform framework that goes to the Peoples' Assembly in
November does indeed remain in this form, it will satisfy the three
political requirements set out above. But its viability as an
operational framework for government is another question entirely.
While it seems likely that it would avoid producing the hopelessly
fractionalized and extremely volatile multi-party politics that
Indonesia experienced in the mid-1950s, there would still be real
scope for division and logjams. Given that it seems unlikely that any
one party will control the House, the legislative bargaining process
between it and the president is likely to be difficult. Further
complicating the situation is the fact that it appears the House may
well have a real ability to vote the president out of office at any
time (by virtue of its dominance of the Peoples' Assembly). Indeed,
and labels notwithstanding, this system may function rather like the
messy parliamentary framework Thailand had in place until very
recently.

Assuming the military does not intervene in party politics, the
machinery of government in Indonesia is going to operate in a manner
very different from the past. There are likely to be both benefits
and costs. On the positive side of the ledger, the political system
will be more accountable and representative, as the president will
now have to share power to a much greater extent with local
representatives of the people. On the negative side, at least in the
short term, this may promote political corruption and severely
complicate the task of putting in place the sorts of major economic
measures needed to restore investor confidence and rebuild the
economy.

Before turning to the economic tasks that lie ahead, it is worth
pausing to reflect on the increasingly Islamic character of politics
in Indonesia as this may well generate misunderstanding in the United
States. The Islamization of Indonesian politics is not just a
function of B.J. Habibie being the country's first truly Muslim
president, or of his key allies (such as the new golkar chairman,
Akbar Tandjung) also being committed Muslims, or of the fact that two
of the three key "opposition" political leaders (Amien Rais and
Abdurahman Wahid) also head very large Islamic social movements. This
phenomenon runs much deeper. As scholars who study Islam in Indonesia
have pointed out, the Islamization of Indonesian politics took hold
roughly a decade ago. Under the controlled political environment of
the New Order, this primarily manifested itself as a social trend
toward increasing piety and calls for higher standards of public
morality. But what will Islamization mean in the more open political
environment that is now evolving?

The answer to this question goes back to the spectrum of Islamic
thinking in Indonesia and the range of socio-religious currents
contained within it. It is certainly true, for instance, that there
are radical Islamic groups such as the Indonesian Institute for the
Islamic World Solidarity (KISDI) and Dewan Dakwah that are associated
with positions that would worry American elites: religious
intolerance, an Islamic state for Indonesia, hostility toward the
United States (and international institutions seen to be dominated by
the United States), and hostility toward Israel. But these groups are
no more representative of the political thinking of mainstream
Muslims in Indonesia than are the hardest-edged groups on the
religious right representative of the political thought of mainstream
Christians in America. In short, radical Islam is but one segment
(and a relatively small one at that) in a broad spectrum.

There is no clear consensus as to what an Islamic policy agenda for government (as distinct from one for opposition) should look like. Nevertheless, and at the risk of oversimplification, while there are major differences between Islamic leaders such as Amien Rais and Abdurahman Wahid, the reality is that neither favors an Islamic state, neither believes in Islamic banking or Islamic economics, and both (whether through conviction or political survival instincts) are working toward a more rather than less inclusive approach to religious diversity. And while there is clearly widespread popular resentment against Chinese Indonesians, both leaders have called for tolerance and understanding and have decried the awful violence directed against them during the riots. Though Amien Rais might flirt with the rhetoric of large-scale economic affirmative action along the lines of Malaysia's New Economic Policy to redress economic imbalances between indigenous Indonesians and Chinese Indonesians, the very different demographic realities of the two countries will ensure that this is never more than a marginal undertaking in Indonesia. In short, while the rhetoric and symbols emanating from Indonesian politics are likely to become increasingly Islamic, the tendency to view this is as inevitably a malign development should be resisted. Compared with many other parts of the Muslim world, the broad mainstream of Indonesian Islam is remarkably tolerant and progressive. It should be nurtured rather than feared and isolated.

The task of building a new and viable political system of government is deeply intertwined with the task of stabilizing and rehabilitating the country's economy. Although a condition necessary for recovery - the departure of Suharto - has been achieved, the challenge remains staggering. If anything, the economy has actually deteriorated since Habibie took power (though this in part reflects the negative impact of the malaise in Japan). The most urgent economic tasks ahead are reasonably clear. At the most basic level, the government must maintain affordable supplies of rice and other household essentials if there is not to be a resurgence of mass rioting and serious starvation problems. At present rice supplies are being maintained, but only on the basis of IMF subsidies, with the price of rice in Indonesia at the time of writing being about half the price on world markets. Without a major currency appreciation, this situation is unlikely to be sustainable for more than a few months.

Second, the banking system must be recapitalized. At present there is systemic insolvency in the Indonesian banking sector. This will require major institutional reform. Until decrepit banks are closed or merged and otherwise viable banks helped to restructure, commercial lending cannot resume.

Third is the closely related issue of resolving private foreign debt. An estimated $60 billion is owed to foreign lenders by firms other than banks. The fact that so much of the debt is held by a wide array of large and medium-sized Indonesian companies has greatly complicated the task of restructuring the debt. A broad framework for negotiations between lenders and borrowers has been reached (the so-called Frankfurt agreement), though for practical purposes it remains largely irrelevant because the exchange rate is still so far from a level at which firms could begin to think of making repayments. Further, on both sides there is a waiting game still in play: Indonesian borrowers are sitting tight in the hope that their debts may be largely or even completely written off, and foreign banks are unwilling to begin heavy discounting of loans until they are sure there is no prospect of a better outcome. And so the issue remains frozen. But there is a very destructive dynamic here: the longer the debt issue remains unresolved the longer the economy will remain in limbo, as firms will not be able to attract the new foreign lending necessary to help revive the economy.

Fourth and most conspicuously, the government needs to find a way to get the exchange rate back up to a level at which international transactions again become viable. This seems likely to require clear progress on all of the preceding issues, plus striking a judicious balance between satisfying the IMF's monetary and fiscal targets on the one hand, and not stifling commercial activity on the other. Finally, in addition to these macroeconomic imperatives, it will also be necessary for the government to take effective measures to address the sheer political anxiety of Chinese Indonesians, who make up the bulk of the country's entrepreneurial community. The anti-Chinese looting and violence of May, the rise of political Islam, and the fear that more democratic politics will be bad for Chinese Indonesians - all these factors combine to encourage them to leave their liquid financial assets offshore. Chinese Indonesians will want to bring their assets back - Indonesia is after all their homeland - but the government will have to work to rebuild their trust and confidence.

All policy options available to the Indonesian government are heavily constrained. To give but one illustration: the budget deficit (made up in large measure of essential food subsidies) is now projected to reach about 9 percent of GDP, which roughly translates to about $12 billion. This will have to be financed almost entirely with international assistance. In recent years the consortium of donors that has supported Indonesia has provided around $5-6 billion. The likelihood of this figure being doubled seems very low. Given that there is no functioning domestic bond market, the only alternative would be for the government to print money - thereby placing itself in breach of the IMF's requirements.

How will Indonesia's economic crisis be stabilized? The most likely scenario (though not the only one) is that the economy will continue to slide until it hits rock bottom - something which cannot now be far off. At that point, when there is no longer any advantage to waiting, foreign lenders and large Indonesian corporations (which still have a reputation worth preserving) or firms in a particularly profitable area of trade will come to some heavily discounted repayment arrangement, while lesser firms will simply disappear and have their debts written off. As this happens lending will be able to begin again, though the economic and social cost of reaching this new economic equilibrium will be very high.

U.S. Interests and Options

Indonesia will come back from this economic crisis. But if it is left to drift without assistance the hardship and dislocation will be very much greater and the process will be an extended one. There are two key areas in which the United States could, in principle, be of major assistance. First, in the short term it could provide generous emergency aid to help with basic human needs such as food, household fuels, and medicines. There has been some assistance of this sort already, but with the exchange rate falling still lower such emergency relief will continue to be needed for some time yet. Second, Washington could use its global leadership to facilitate a speedy resolution on the corporate debt issue. This problem must be overcome before the economy can improve. The United States played a pivotal role in negotiations on Korean bank debt, but has been little involved in the very much more messy Indonesian debt problem. Things have now reached a point at which the U.S. Treasury might be able to persuade foreign banks to cut their losses and make a deal sooner rather than later. Clearly this would involve major losses for those banks - but this now seems unavoidable anyway, making it largely an issue of timing. Further, given that most of the corporate debt in Indonesia is held by Japanese and European banks, the burden falling on U.S. banks would be relatively small. Beyond these concrete economic measures, what Indonesia will need most over the next few years is sympathetic understanding and support, as it grapples with what are essentially internal problems.

Why should the United States pay serious attention to Indonesia's plight and consider taking serious steps to help it? After all, Indonesia does not pose any obvious or dire threat to America. It does not have nuclear weapons pointed this way, it is not a large holder of U.S. Treasury bonds, it does not pose a frightening immigration threat on America's doorstep, and it does not have an electorally active domestic lobby in the United States ready to mobilize on its behalf.

Despite the absence of some of these classic ingredients for winning U.S. attention and support, there are strong reasons why Washington should look very seriously at coming to Indonesia's aid in a more vigorous fashion than it has to date. One is strategic. Over the past several decades, Indonesia has basically been a "good news" story as far as U.S. foreign policy calculations are concerned, and accordingly it has received little attention. This will change, however, if Indonesia is in serious distress for a sustained period. Arguing the strategic significance of any particular place is hard in the abstract, but if the concern and efforts of countries as diverse as Japan, Singapore, and Australia are anything to go by, Indonesia's woes are not to be taken lightly. The longer economic recovery takes, the greater the likelihood of serious political instability and a return to military-based government. There are powerful demographic considerations at work here. Prior to the economic crash, it was estimated that Indonesia needed an economic growth rate of 5-6 percent annually just to generate enough jobs for the hundreds of thousands of new entrants to the labor force. Such a growth rate is now but a distant dream, but the problem remains. Although it is not being openly discussed today, no one should discount the possibility that in one to two years Indonesia's political situation could become very ugly indeed if the economic scenarios at the bleak end of the spectrum come to pass.

The implications of Indonesia's internal problems go well beyond its boundaries. If Indonesia is in serious distress, the Association of Southeast Asian Nations (ASEAN) is likely to become a lame institution, since Indonesia is pivotal to the region. This would entail real costs for U.S. foreign policy. While members of ASEAN still only account for a modest share of the world's GDP and military power, acting collectively they have managed to punch well above their weight in world affairs in recent decades. Not only did ASEAN help to bring stability to a region that had previously been one of the most volatile and violent in the world, but it was within its framework that the region prospered in a way that no other developing region had ever before - or since. By the 1990s all the major powers of the world found it an organization worth courting assiduously. Despite its limitations and self-important rhetoric, ASEAN has been central to the evolving multilateral framework for economic and security cooperation via institutions such as APEC and the ASEAN Regional Forum. More broadly, ASEAN has the potential of providing a useful counterpoint to China in the region.

Why should the United States pay serious attention to Indonesia's plight and consider taking serious steps to help it? After all, Indonesia does not pose any obvious or dire threat to America. It does not have nuclear weapons pointed this way, it is not a large holder of U.S. Treasury bonds, it does not pose a frightening immigration threat on America's doorstep, and it does not have an electorally active domestic lobby in the United States ready to mobilize on its behalf.

Despite the absence of some of these classic ingredients for winning U.S. attention and support, there are strong reasons why Washington should look very seriously at coming to Indonesia's aid in a more vigorous fashion than it has to date. One is strategic. Over the past several decades, Indonesia has basically been a "good news" story as far as U.S. foreign policy calculations are concerned, and accordingly it has received little attention. This will change, however, if Indonesia is in serious distress for a sustained period. Arguing the strategic significance of any particular place is hard in the abstract, but if the concern and efforts of countries as diverse as Japan, Singapore, and Australia are anything to go by, Indonesia's woes are not to be taken lightly. The longer economic recovery takes, the greater the likelihood of serious political instability and a return to military-based government. There are powerful demographic considerations at work here. Prior to the economic crash, it was estimated that Indonesia needed an economic growth rate of 5-6 percent annually just to generate enough jobs for the hundreds of thousands of new entrants to the labor force. Such a growth rate is now but a distant dream, but the problem remains. Although it is not being openly discussed today, no one should discount the possibility that in one to two years Indonesia's political situation could become very ugly indeed if the economic scenarios at the bleak end of the spectrum come to pass.

The implications of Indonesia's internal problems go well beyond its boundaries. If Indonesia is in serious distress, the Association of Southeast Asian Nations (ASEAN) is likely to become a lame institution, since Indonesia is pivotal to the region. This would entail real costs for U.S. foreign policy. While members of ASEAN still only account for a modest share of the world's GDP and military power, acting collectively they have managed to punch well above their weight in world affairs in recent decades. Not only did ASEAN help to bring stability to a region that had previously been one of the most volatile and violent in the world, but it was within its framework that the region prospered in a way that no other developing region had ever before - or since. By the 1990s all the major powers of the world found it an organization worth courting assiduously. Despite its limitations and self-important rhetoric, ASEAN has been central to the evolving multilateral framework for economic and security cooperation via institutions such as APEC and the ASEAN Regional Forum. More broadly, ASEAN has the potential of providing a useful counterpoint to China in the region.

Interestingly, there is remarkably little expectation in Indonesia (or elsewhere in the region) that this is about to change. There is an irony here that is not lost on Indonesia, or other Western Pacific countries. For even though the United States enjoys unparalleled influence globally, is riding on the back of a long economic boom, and has been quick to proffer policy prescriptions, few in Indonesia or elsewhere in the region hold out much hope that the United States will do significantly more to help. It may be that this is as things should be, with neighboring or regional countries looking after their own. But Washington should not delude itself as to the longer term foreign policy consequences of being "absent" during Indonesia's hour of need.

Essay Types: Essay