Revisiting The Past: Analyzing Indonesia’s 1998 Monetary Crisis

The 1998 Monetary Crisis was a dark history for Indonesia. It marked a period of severe economic turmoil that permeated every facet of Indonesian life.

The 1998 Monetary Crisis was a dark history for Indonesia. It marked a period of severe economic turmoil that permeated every facet of Indonesian life and significantly caused generational harm and traumas, especially the underprivileged and Chinese-Indonesian communities. Triggered by a combination of currency devaluation, declining investor confidence, and the broader harm of the Asian Financial Crisis, the Indonesian economy spiraled into a recession, causing a dramatic increase in food prices, such as rice, that have become a staple food for millions.

The Indonesian Rupiah has been under pressure since July 1997, concurrently with the Thai Baht’s sharp fall in mid-97. Between December 1996 and January 1998, the exchange rate of the Rupiah plummeted dramatically from 2400 Rupiah to the US dollar to 16000 Rupiah to the US dollar (Picker, 1999). In 1998, the inflation rate reached a double-digit level of 65%, becoming the worst compared to Thailand and South Korea (Indonesia Investment, 2019).

The inflation resulted in unemployment, poverty, food insecurity, and malnutrition. Crisis-affected firms must mass lay off their workers and even shut down their businesses due to sudden and uncontrollable inflation. Although no significant job losses were recorded in any official governmental agency bodies, the International Monetary Fund projected that around 11.8% of all Indonesian households and average household consumption decreased by 30%, which are still considerable numbers overall. Moreover, according to the official figures provided by the Central Bureau of Statistics, poverty in Indonesia grew from 22.5 million (11.3%) in 1996 to 36.5 million (17.9%) in 1998, predominantly impacted by food insecurity and malnutrition (Soekirman, 2001, p.57). Food production decreased by 20-30%, also contributed by the abnormal weather of El Nino in the eastern part of the country, while food prices kept escalating by 50-100% and more since 1997, causing around 20 percent of 200 million Indonesians would be living under the absolute poverty line as a result of the crisis (Baker, 1998, p.3).

The biggest question is: Why? Indonesia had remarkable economic growth before 1997 under Soeharto’s administration. He is a military-dictator leader appointed in March 1967 after the coup d’etat conducted by the Indonesian Communist Party (PKI) (The Editors of Encyclopedia Britannica, 2019). Under his presidency, Indonesia’s economy increased at an average annual rate of 7 percent, bringing Indonesia out of the rank of ”low-income countries; into the ”lower-middle-income countries” by utilizing high rates of capital investment growth from foreign entities and high rates of Total Factor Productivity (TFP) growth, mainly agriculture and manufacturing exports (Wee, 2009, p. 69). As a result, income per capita rose from  U.S.$ 100 to U.S.$ 1,000, and absolute poverty was reduced from 40% of the population in 1976 to 11% in 1996 (Wee, 2009, p. 69).

The confusion can be understood by analyzing possible domestic and external factors.

Domestic reasons are mainly correlated with the fragile banking system and the dismissive response of the incumbent government. Indonesia has adopted a rapid financial liberalization in its banking system with minimum regulation and supervision. Banks applied a long-term policy and operated on a collateral basis, with land and buildings as the main collateral for bank loans (Nasution, 2000, p. 149), encouraging the corporate sector to subscribe to a high debt-equity ratio. As a result, the expansion of non-tradable goods and non-performing loans (NPL) worsened the crisis since banks lacked financial liquidity to face the crisis, causing the major devaluation of the Rupiah and higher interest rates in loans. This phenomenon also caused major foreign direct investment (FDI) to decrease significantly, a prerequisite for Indonesia’s economic success.

Moreover, Soeharto’s response to the crisis is politically saturated. Instead of defending the Rupiah currency, his main developmental response was to float the Rupiah freely and raise interest rates to attract rupiah deposits, but the Rupiah continuously depreciated (Baker, 1998, p. 2). Due to the shutdown of sixteen banks suggested by the IMF, Soeharto saw that IMF solutions did not sustainably solve the problem, further validating his superiority complex. He released his budget, which he thought would give continued growth, but it was miscalculated, and Rupiah kept crashing.

Several external factors consist of three reasons: 1) signs of financial contagion through Thailand Baht, 2) investor behavior, and 3) IMF policy recommendation. Firstly, contagion here refers to the spread of an economic crisis from one region to another due to the interconnectedness of the domestic and global economy (Ganti, 2019). In this context, Iriana & Sjoholm (2002) applied the statistical methodology to analyze correlation coefficients between Thailand and the Indonesian economy by approximately 2% in exchange rates and 0.5% in the stock market, demonstrating difficulties in Thailand were inherently transmitted to the Indonesian currency markets (p. 141-142). According to the “wake-up call” hypothesis formally introduced by Goldstein (1998), Thailand’sThailand’s Baht downfall also acted as a wake-up call for international investors to reassess Indonesia’sIndonesia’s macroeconomic performance, influencing investor behavior (Goldstein, 1998). During the crisis, the International Monetary Fund, one of the prominent Bretton Woods institutions tasked to solve financial issues encountered by states, intervened in the crisis and gave some policy recommendations to Indonesia. The measures included short-term stabilization, medium-term economic reform, and market infrastructure development to reduce the asymmetry of information and transaction costs (Nasution, 2002). This generated problematic outputs since eighteen banks were closed in November 1997 due to IMF recommendations, but depositor insurance was absent. It decreased public confidence and resulted in panic and a bank run, signaling a lack of international support to protect foreign investments in Indonesia.

Consequently, more than 10 billion dollars were withdrawn by both domestic and international investors from Indonesia, representing a significant outflow of capital and deepening the economic downturn (Grenville & Rajah, 2020). Other agreements expounded in the Memorandum of Economic and Financial Policies that aimed to restructure Indonesia’sIndonesia’s monetary policy and banking system brought worse outcomes, such as crimes against humanity in Timor Leste (Farsia, 2021, pp. 23-24). Therefore, the three above-explained reasons became the primary external factors. It all started with contagious economic speculation from Thailand, which affected domestic and international investors and was further worsened by IMF intervention.

In the end, the crisis was caused by multiple nuanced factors, both external and internal. From economic contagion to dismissive domestic policies, the 1998 Indonesian monetary crisis became one of the biggest crises in Indonesia. It caused food crises and radical actions, such as mass killings and business destructions, that have become a sensitive topic in Indonesian society.

Yehezkiel Vito
Yehezkiel Vito
Vito is a bachelor student in international relations at Gadjah Mada University, Indonesia. I am a highly motivated and curious individual with a passion for exploring new opportunities and making a positive impact with a keen interest in diplomacy and global issues. He is eager to gain hands-on experience in various professional job roles and volunteering initiatives.