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The Asian Financial Crisis 1997

Indonesia's Political Collapse: The Crisis Within the Crisis

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Why Did Indonesia's Currency Crisis Become a Political Revolution?

Every country caught in the 1997 Asian crisis experienced severe economic pain. But only one country experienced the collapse of its governing regime, widespread social violence, and a political transformation so fundamental that it qualified as a revolution. Indonesia's crisis was qualitatively different from Thailand's, Malaysia's, or even South Korea's — not only in severity but in the intersection of economic and political dynamics that made it simultaneously harder to manage and more consequential in its aftermath. The rupiah fell over 80 percent, the worst depreciation of any major crisis currency. GDP contracted 13 percent in 1998 — the worst peacetime contraction of the modern era for a major economy. President Suharto, who had ruled for 32 years and who international institutions had treated as a guarantor of stability, fell from power in May 1998 under conditions of social unrest that included ethnic violence against the Chinese Indonesian minority. Understanding why Indonesia's crisis was so much worse than its neighbors' illuminates the intersection of economic vulnerability, political economy, and institutional quality that determines how severely economic shocks translate into human suffering.

Cronism in credit: The practice of allocating bank credit based on political connections or family relationships rather than economic criteria. In Indonesia under Suharto, a substantial proportion of bank lending was directed to businesses owned by the Suharto family or their associates — creating a banking system whose apparent solvency depended on political stability rather than underlying credit quality.

Key Takeaways​

  • Indonesia's rupiah depreciated over 80 percent from its pre-crisis level to its January 1998 trough — more than any other major crisis currency — reflecting both genuine fundamental vulnerabilities and a cascading loss of confidence in the political system.
  • Indonesia's banking system was extensively penetrated by cronyism: loans to Suharto family businesses and political associates were a substantial proportion of total bank credit, and these were the first to experience non-performance.
  • The IMF's initial bank closure condition — closing 16 insolvent banks, several of which were owned by Suharto associates — created a deposit run that worsened the crisis it was intended to address.
  • The IMF's direct confrontation with Suharto's political economy through conditionality — demanding reduction of family monopolies and subsidies — was analytically correct but politically destabilizing during an acute crisis.
  • Social violence in Jakarta and other cities in May 1998 — much of it directed at the ethnic Chinese minority that was associated with business ownership — reflected decades of political repression and economic inequality being released simultaneously.
  • Suharto's resignation in May 1998 ended 32 years of authoritarian rule; his successor Habibie inherited an economy in collapse with political institutions that had never operated independently of personal authority.

Indonesia's Pre-Crisis Structure​

Indonesia's 1997 crisis cannot be understood without appreciating the political economy of the Suharto era.

Suharto had ruled Indonesia since 1966, when he displaced Sukarno in circumstances that involved mass killings of suspected communists that claimed hundreds of thousands of lives. His "New Order" regime combined authoritarian political control with an economic development strategy that achieved genuine success: per capita income increased dramatically, poverty fell, basic infrastructure was built.

The political economy that underpinned the New Order was a system of patron-client relationships. Business licenses, credit allocation, and government contracts were distributed to entities connected to the Suharto family and to military-affiliated businesses. The Suharto children — six of them, including Hutomo Mandala Putra ("Tommy"), Titiek, and Siti Hardiyanti ("Tutut") — controlled businesses spanning automobiles, toll roads, television networks, cloves, and timber. Suharto's business associates controlled additional sectors.

This crony economy was not merely inefficient; it was fragile. The profitability of crony businesses depended on political protection — preferential contracts, credit allocation, regulatory advantages — that could evaporate if the political structure changed. International investors accepted this arrangement because Suharto seemed permanent and because real economic growth was occurring alongside the extraction.

By 1997, Indonesia had genuine economic vulnerabilities similar to Thailand's: a current account deficit financed by short-term capital flows, a banking system with non-performing loans, and corporations with dollar borrowing against rupiah revenues. But Indonesia's banking system had an additional layer of fragility: a substantial proportion of bank lending was directed to crony businesses that were not economically viable without political support.

The Rupiah's Collapse​

The rupiah initially came under pressure in August 1997 as part of the regional contagion. Indonesia attempted to defend a float band, widened the band on August 14, and then floated entirely. The initial float produced depreciation from approximately 2,400 per dollar to 3,000–4,000 per dollar — severe but not catastrophic.

The deeper collapse — from 4,000 to 17,000 rupiah per dollar at the January 1998 trough — reflected the interaction of economic and political uncertainty that was specific to Indonesia.

First IMF program failure. Indonesia signed its first IMF program in October 1997, which included the requirement to close 16 insolvent banks. The bank closures — announced without adequate preparation or deposit insurance mechanisms — triggered immediate deposit flight from the banking system. Depositors at the remaining banks concluded that they could not distinguish safe banks from unsafe ones and withdrew deposits as a precaution.

The deposit flight depleted the banking system's liquidity and forced the Bank of Indonesia to provide emergency liquidity support. The liquidity support expanded the money supply and contributed to the continued rupiah depreciation. The IMF condition intended to strengthen the banking system by closing bad institutions instead accelerated the banking crisis.

Suharto's response. Suharto's response to the IMF program was grudging compliance combined with continued protection of family business interests. He signed the IMF agreement while implementation was slow; he appeared in photographs with the IMF's Managing Director Camdessus in an image that was globally read as humiliating.

More significantly, Suharto proposed in early 1998 to establish a currency board — pegging the rupiah to the dollar at approximately 5,500. The currency board proposal was abandoned under intense pressure from the IMF and US Treasury, who argued that it was technically infeasible given Indonesia's reserve position and would accelerate capital flight. The episode damaged Suharto's remaining international credibility and contributed to investor uncertainty.

The Political Implosion​

As the economic crisis deepened in early 1998, social pressure mounted in ways that the Suharto system had not experienced in three decades.

Food and fuel price increases. The rupiah's depreciation dramatically increased the cost of imported goods, including food staples and fuel. Subsidies that had kept consumer prices stable were now unaffordable at the new exchange rate. When subsidy reductions were announced as part of IMF conditionality, prices for basic goods rose sharply.

Ethnic tensions. The economic hardship concentrated public anger on the ethnic Chinese Indonesian minority — approximately 3 percent of the population but controlling a disproportionate share of business wealth. Years of institutionalized resentment, amplified by the economic shock, produced violence that was partly spontaneous and partly, by many accounts, organized or tolerated by elements of the security forces.

In May 1998, rioting spread through Jakarta and several other cities. The Chinese Indonesian community — which had been a backbone of the business economy for generations — was targeted; businesses were looted and burned, and hundreds or thousands of people were killed in the violence. The specific figure is disputed; Indonesian authorities were not transparent about the scale.

University protests. Students occupied the parliament building in Jakarta in mid-May 1998, demanding Suharto's resignation. The military — whose loyalty Suharto had counted on — did not forcibly remove the protesters.

On May 21, 1998, Suharto resigned and transferred power to his vice president, B.J. Habibie. The transfer ended 32 years of personal authoritarian rule and began a transition whose democratic quality and economic implications were deeply uncertain at the moment it occurred.

The Habibie Transition​

B.J. Habibie had been Suharto's chosen successor and was deeply embedded in the New Order's technology-industrial project (he had headed the state aircraft manufacturer IPTN and other industrial ventures). His legitimacy as president was immediately questioned both domestically — by reformers who saw him as Suharto's surrogate — and internationally.

Habibie's economic policy was largely technocratic continuity: he maintained the IMF program framework, appointed professional economic ministers, and avoided the worst policy errors that would have accelerated the economic deterioration. But his political legitimacy was limited, and the institutional transitions required for economic recovery — judicial reform, anti-corruption measures, decentralization — moved slowly under his presidency.

The crisis's immediate economic legacy was devastating. By mid-1998:

  • Approximately 15–20 million Indonesians had fallen into poverty as the crisis reversed years of poverty reduction
  • Unemployment had risen from approximately 4 percent to 20+ percent in the formal sector
  • The banking system required government recapitalization equivalent to approximately 50 percent of GDP
  • Corporate dollar debt of approximately $60–70 billion remained largely unresolved

Indonesia's banking system recapitalization cost was among the most expensive in history by the metric of GDP percentage — reflecting both the scale of the initial mismatch and the depth of the rupiah depreciation that made dollar obligations so much more expensive in rupiah terms.

Recovery: Slow and Uneven​

Indonesia's recovery from the 1997–99 crisis was the slowest among the major affected countries. Several factors limited recovery speed:

Political transition complexity. The transition from 32 years of Suharto's personal rule to democratic governance was institutionally difficult. Habibie's presidency ended in 1999; Abdurrahman Wahid (Gus Dur) was elected president in democratic elections but was subsequently impeached in 2001; Megawati Sukarnoputri succeeded him. The political transitions disrupted economic policymaking continuity.

Debt restructuring complexity. Indonesia's corporate dollar debt restructuring required negotiations with hundreds of individual creditors across multiple jurisdictions. The Jakarta Initiative Task Force — established to facilitate corporate debt restructuring — operated slowly, partly because Indonesia's legal system was inadequate for complex cross-border insolvency processes.

Banking system resolution cost. The Indonesian Bank Restructuring Agency (IBRA) managed asset recovery from closed and restructured banks — a process that involved managing assets equivalent to a substantial fraction of GDP. Asset recovery was slow and at significant discount to book value.

Natural resource dependency. Indonesia's recovery was also hindered by commodity price weakness in 1998–2000. As a major oil, gas, coal, and palm oil producer, Indonesia's fiscal and export revenues were linked to commodity prices that were weak in the late 1990s.

GDP did not return to pre-crisis levels until approximately 2001–02. Poverty rates that had fallen substantially during the Suharto era rose sharply in 1998 and recovered only gradually. The distributional consequences of the crisis were borne disproportionately by the poor and by the ethnic Chinese minority who had suffered the physical violence of 1998.

Long-Term Institutional Legacy​

Indonesia's post-1998 political transformation had genuine institutional consequences over the following decade.

Democratic transition. Indonesia held its first genuinely free and fair national elections in 1999 and has maintained democratic governance since. The decentralization of political and fiscal authority to regional governments — one of the most significant structural reforms of the Wahid and Megawati years — fundamentally changed Indonesia's political economy.

Anti-corruption institutions. The Corruption Eradication Commission (KPK), established in 2002, became one of Southeast Asia's more effective anti-corruption agencies, securing convictions of senior politicians and officials that would have been unimaginable in the Suharto era.

Economic resilience improvement. Indonesia's economic management improved significantly in the 2000s. Macroeconomic stability — low inflation, manageable deficits, floating exchange rate — replaced the crisis vulnerabilities. The 2008 global crisis, while affecting Indonesia, did not produce a rerun of 1997–98; Indonesia maintained positive growth throughout.

Common Mistakes in Analyzing Indonesia's Crisis​

Attributing the severity primarily to IMF conditionality. IMF conditionality — particularly the initial bank closures and the opposition to the currency board — contributed to the crisis's severity. But Indonesia's underlying vulnerabilities (crony banking, dollar corporate debt, political fragility) were the primary cause of the depth of the collapse. Better IMF program design might have prevented some of the amplification; it would not have prevented the fundamental adjustment.

Treating the ethnic violence as separate from the economic crisis. The 1998 ethnic violence was not exogenous to the economic crisis; it was generated by the intersection of economic shock and decades of institutionalized resentment. The specific targeting of the Chinese Indonesian community reflected the political economy of the Suharto era, in which the Chinese business community had been simultaneously economically prominent and politically exposed.

Underestimating the democratic transformation's significance. Indonesia's transition from Suharto's authoritarian rule to functional democracy was not simply a political event with economic costs — it was an institutional transformation with long-term positive consequences that were not visible in the immediate crisis aftermath.

Frequently Asked Questions​

Did the IMF cause Indonesia's crisis to be worse than it needed to be? The bank closure decision in October 1997 demonstrably worsened the banking crisis by triggering deposit flight without adequate preparation. Whether the overall IMF program was net positive or net negative for Indonesia's outcome is more contested. Without the IMF framework and external financing, Indonesia might have faced even worse outcomes (complete banking system collapse, hyperinflation). With better program design, the amplification of the crisis might have been reduced.

What happened to the Suharto family's wealth? Post-Suharto attempts to recover assets from the Suharto family were partially successful but limited by institutional constraints. Tommy Suharto was convicted of ordering the assassination of a judge who had ruled against him in 2000 and served a prison sentence. Asset recovery proceedings produced some restitution but left much of the family's accumulated wealth intact.

How did Indonesia's experience affect IMF reform discussions? Indonesia's crisis, combined with Korea's and Thailand's, was central to the most intensive reform debate in the IMF's history. The Meltzer Commission, established by the US Congress in 1999, recommended significant reduction in the Fund's scope and conditionality. While the most radical proposals were not adopted, the Asian crisis experience produced meaningful changes in how the IMF approaches capital account crises, bank restructuring recommendations, and social safety net protection during adjustment.

Summary​

Indonesia's crisis was the most severe and most consequential of the 1997 Asian financial crisis, combining currency collapse of over 80 percent, GDP decline of 13 percent, banking system insolvency requiring fiscal recapitalization equivalent to 50 percent of GDP, and the political collapse of Suharto's 32-year authoritarian regime. The severity reflected the specific interaction of genuine economic vulnerabilities (dollar corporate debt, crony banking system fragility) with political fragility that made the standard crisis management tools counterproductive: the IMF's bank closure condition accelerated deposit flight; conditionality requirements to reduce Suharto family privileges politically destabilized the regime during the acute crisis. Social violence in May 1998, directed primarily at the ethnic Chinese minority, reflected the release of decades of political repression and inequality under the pressure of the economic shock. Suharto's resignation on May 21, 1998 began Indonesia's democratic transition — a process that produced genuine institutional improvements over the following decade even as the immediate economic recovery was slow and the human costs of the crisis were severe and unequally distributed.

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