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Executive Summary #1291es on Asia

June 4, 1999

Executive Summary: Promoting Democracy and Economic Reform in Indonesia

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Indonesia is important to the safety, stability, and prosperity of Southeast Asia. The world's fourth most populous country, Indonesia controls strategic sea-lanes through which pass 40 percent of the world's commerce, including 80 percent of Japan's oil supply and 70 percent of South Korea's. Before falling victim to the effects of the Asian economic crisis in August 1997, Indonesia's economy had averaged 7 percent growth over the previous 25 years despite being riddled with corruption and inefficiency.

The Asian economic crisis hit Indonesia harder than any other country. The value of the currency plummeted from around 2,450 to the dollar before the crisis to 17,000 to the dollar at the worst point. Interest rates soared to over 50 percent in 1998, and inflation to over 77 percent. Because of the tremendous depreciation in the value of the currency, businesses were unable to repay their debts and insolvent banks were unable to extend credit. The Indonesian economy eventually would shrink by 13.7 percent in 1998.

This tremendous economic hardship led quickly to major changes in the political system. Indonesians had seemed willing to tolerate political repression during economic good times; they were not so tolerant toward what they saw as their government's ineffective response to the effects of the economic crisis. They took to the streets in violent demonstrations that killed over 1,000 and culminated in the May 1998 resignation of President Suharto, who had ruled with an iron grip for 32 years.

The political system was liberalized dramatically under B. J. Habibie, Suharto's successor as president. Habibie has released political prisoners, relaxed restrictions on the press, and allowed the free formation of political parties. The president's tenure was fixed at two five-year terms. Important parliamentary elections were set for June 1999, with selection of the next president to follow in November. In a surprise development, Habibie announced that the restive Indonesian province of East Timor, invaded and annexed by Jakarta in the mid-1970s, would be given the opportunity in August 1999 to decide between independence and greater autonomy within Indonesia.

This major political development has been marred, however, by Indonesian military support for pro-Jakarta militias in East Timor which have been killing and intimidating supporters of independence. Indonesian military support for these militias is particularly disturbing because violence of any kind makes investors wary of Indonesia. The peaceful and credible conduct of the referendum on East Timor and Indonesia's other major elections in 1999 would be a significant milestone in the re-establishment of investor confidence.

Indonesia's record on much-needed economic reform also undermines investor confidence. Jakarta has been slow to implement the kinds of reforms needed to restore the economy. These include pruning and restructuring the bloated and crippled financial sector, implementing meaningful bankruptcy reform, and reducing barriers to trade and investment. These reforms are the minimum required to regain the faith of international investors.

Indonesia's economic and political challenges go hand in hand. An Indonesia mired in economic stagnation is less likely to be able to settle its political differences peacefully and more likely to be beset by ethnic, religious, and sectarian violence. This harms Indonesia's future economic prospects, creating a vicious cycle of economic and political degeneration that threatens the stability of the Southeast Asia region.

With important economic and security interests in Southeast Asia, the United States has a stake in preventing Indonesia's devolution into chaos. Chaos in Indonesia could threaten nascent economic recoveries underway elsewhere in the region. It also could put at risk the critically important sea-lanes under Jakarta's control, jeopardizing the commercial interests of the United States, the world's largest trading power.

Although Indonesians ultimately are responsible for their own political and economic fate, there are steps that Washington can take to facilitate Indonesia's transformation to a more open economic and political system:

  • Offer assistance to appropriate non-governmental organizations to help assure that Indonesia's three major votes during 1999 are conducted peacefully and credibly, and contribute to the strengthening and consolidation of democracy.

  • Declare that the United States and the world will be watching the process and outcome of Indonesia's votes in 1999.

  • Avoid peacekeeping commitments in East Timor, which would be more likely to freeze the conflict in place than to solve the underlying differences between the parties.

  • Press Indonesia to implement badly needed economic reforms and not rely on International Monetary Fund assistance to solve its economic problems.

  • Promote reforms in Indonesia's military and consider rebuilding ties with the military if it acts responsibly during all three of Indonesia's votes during 1999. Restoration of Indonesia's participation in the International Military Education and Training program could help move the Indonesian military toward greater professionalism, civilian control, and respect for human rights.

America's interest in a peaceful and prosperous Southeast Asia requires that it assist Indonesia's further evolution toward democracy and free-market economics. An Indonesia restored to economic growth and progressing toward genuine democracy is in the interest of Indonesians and Americans alike.

John T. Dori is a former Research Associate in The Asian Studies Center at The Heritage Foundation.

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