In 1996 Indonesia was ranked 7th in the IMF's top ten emerging economies. Real GDP grew at an average of 8% per annum from 1990-96. Investor sentiment was optimistic and even allowing for the political uncertainty which surrounded the Suharto regime, the future looked bright.

Chickens have become a unaffordable luxury for many

Today, the economy is in desparate straits as a result of riots, food shortages, a devastated corporate sector and a vastly depreciated currency.

Over the past three decades, Suharto allowed a peculiar form of state nepotism to develop in Indonesia. The fortunes of his children have become part of the bizarre web of stories involving the soothsayers and snake-oil salesmen who populate his court. But this obscures the extent to which the Indonesian economy has grown over the past 20 years and the factors behind the crisis.

Fast and substantial growth

As recently as 1980, 98% of Indonesia's merchandise exports comprised of oil and primary commodities. There was little industry. The fall in oil prices in the middle of the decade intensified the need for the economy to diversify into manufactured exports. Intensive development over a relatively short period saw the industrial sector grow to account for over 50% of export earnings and nearly 43% of GDP by 1996, according to the Asian Development Bank.

This economic hothouse was fuelled by large inflows of capital from western and Japanese banks. The Indonesian rupiah traded within a controlled band against the US dollar and so offered investors currency stability. A weak dollar made exports even more competitive, particularly in its largest export market, Japan.

Indonesia's debt - country share

Foreign capital poured into the country as the markets came to believe in the East Asian miracle. Reflecting a pattern across the region, the level of recorded portfolio investment in Indonesia jumped from $338 million in 1990 to over $7billion in 1995.

The total level of external indebtedness jumped from just over $20 billion in 1980 to levels now exceeding $130 billion, according to the latest government estimates. "Over-hyping led to quite a lot of irresponsible lending," maintains Prof. Anne Booth, an Indonesian expert at the School of Oriental and African Studies in London. "This is as much a lending crisis as a borrowing crisis."

As in other Asian economies, although the visible hand of the government may have been instrumental in facilitating foreign investment, it was the private sector in Indonesia which took on the burden of debt, confident that growth would continue at rates of over 7%.

Paul Krugman, an economics professor at MIT, has suggested that financial intermediaries in the Southeast Asian economies were insufficiently regulated but implicitly backed up by government guarantee. The result was bank lending without a proper assessment of risk. A Jakarta taxi company with the unfortunate name 'Steady Safe' became world famous as the $230 million bad loan which broke the back of Hong Kong's Peregrine Investment Holdings in January.

Tide turns against Asian Tigers

Problems began to emerge from the second half of 1995 when the value of the US dollar began to rise, reflecting its strengthening economy. The local Asian currencies' pegged arrangements with the dollar made their exported goods look less cheap and the return on investments from firms dependent on the export market less certain.

In May 1997 attacks on the Czech krona heralded the reversal in investor sentiment towards emerging markets dependent on large inflows of short-term debt and semi-fixed exchange rates.

The Thai authorities abandoned their dollar peg on July 2nd and the baht plummeted. It was the signal the markets needed to test the other currencies in the region.

Indonesia won praise from the IMF for acting promptly by increasing interest rates and allowing its currency to float in August. But as the rupiah continued to fall the extent of the exposure of the Indonesian private sector to foreign debt became horribly clear.

Suddenly the uncertain future of the 76 year-old Suharto's regime gained a new significance for investors.

Appeal for outside help

In October the Indonesian authorities went to the IMF to seek assistance. On November 4th , they agreed to the terms of a rescue package allowing for debt relief of up to $43 billion.

But the crisis continued as investors doubted the authorities' intention to carry through promised reforms. Nerves were further set on edge in early December when it was rumoured that Suharto had suffered a stroke.

IMF officials: tough negotiations in Jakarta

The rumours of his demise were greatly exaggerated when the president appeared in parliament on January 6th to announce a wildly over-optimistic budget which would have violated the terms of their IMF agreement. The rupiah crashed to over 10,000 against the dollar over the following days.

The IMF returned to Jakarta and a new budget was announced on January 23rd. Suharto caused further concern when he seemed intent on putting the rupiah under a currency board system.

Future remains uncertain

President Suharto's successor, BJ Habibie has struggled to restore market confidence - with limited success. The outlook remains extremely bleak as the economy remains mired in debt.

"At levels of 9,000 rupiah to the dollar about 80% of all listed Indonesian companies are technically bankrupt," according to Justin Bowles, Asia analyst with Dun & Bradstreet UK, "but current bankruptcy laws are so antiquated that it is almost impossible to liquidate failed firms."

Illness fears hit the markets

The immediate future depends on an arrangement being agreed between borrowers and lenders and already there are signs this is happening with many international banks recently announcing large bad loans provisions.

Beyond that, the direction the Indonesian economy will take is uncertain, even leaving aside the country's political turmoil.