Indonesia: A Nation Holding Its Breath

As the army tightens its grip, turmoil could easily escalate

Still mired in the East Timor mess, Indonesia is turning its destructive impulses inward. Behind the scenes, the army has already pushed the wobbly government of President B. J. Habibie to the side. As General Wiranto tightens his grip, the question of the hour is how far he intends to go. The military's commander-in-chief says he is committed to keeping order while parliament elects a new President, probably in late October. But if Wiranto's hand is too heavy--or if he tries to forestall the election--he will almost certainly precipitate more bloodshed in Jakarta and other restive cities.

Whatever the army does next, it has already turned a nation on the road to political and economic recovery into a tinderbox. Foreign investors and international lending agencies, shocked by the terror unleashed in East Timor, now worry about the stability of any new government, civilian or military. Key bank buyouts, aid installments, infrastructure projects, and privatizations will remain on hold until new leaders are established--and it's known whether the nation's democratic aspirations will be accommodated or suppressed. "This country could easily fall into a fatal spin," says a foreign banker. Adds an official of International Finance Corp., the World Bank's direct-investment arm: "No one's going to make any decisions until we know who's in charge."

That's not clear right now. Since early September, diplomats in Jakarta say, Wiranto and his top generals have held daily meetings with Habibie, effectively disabling the civilian government and taking control of the national agenda. More recently, the army and five Islamic parties have been leaning on Habibie to resign. Even aside from the military's threatening shadow, the Habibie government has been discredited by a banking scandal, the bloodbath in East Timor, and deadly riots prompted by an army-backed security bill now awaiting the President's signature.

IN LIMBO. The uncertainty brings the nation to the edge of a new economic free fall. In the past month, the International Monetary Fund, the World Bank, and the Asian Development Bank have suspended scheduled payments and new commitments worth nearly $2 billion. On Sept. 27, Japan halted $600 million in aid tied to World Bank disbursements. A balanced budget and repairs to the banking system are now in jeopardy; inflation may soar. And an economy forecast to grow modestly this year is now expected to shrink by 2%.

Stalled deals litter the economic landscape. Jakarta wanted to sell $2 billion worth of state-held assets this year; it's unlikely to clear more than the $850 million raised earlier this year. The shortfall is forcing abrupt--and stunning--cutbacks. Perusahaan Listrik Negara, a state utility, is paying the Paiton power plant in East Java half the 8 cents per-kilowatt-hour tariff Paiton execs say they need to break even. The plant is owned by General Electric Co. and Edison Mission Energy of Irvine, Calif.

Confidence won't be easily restored. Until the terror in East Timor, the prospect of a political role for Wiranto--who has made no secret of his ambitions for office--was widely welcomed. He was seen as having the power to stabilize the country and force the corrupt bureaucracy to implement the painful terms of the IMF's $43 billion aid package. Many considered Wiranto an ideal vice-presidential running mate for Megawati Sukarnoputri, whose Indonesian Democratic Party of Struggle won handily in national elections last June. "That would have been the dream ticket for the World Bank, the IMF, and institutional investors," says a foreign investment banker. "They would have saved enough face to keep on lending and investing."

Now, Wiranto bears with him less promise than threat. World Bank officials acknowledge privately that many foreign governments no longer want to work with him. Even if a civilian government is installed without him, the military's preponderant position suggests to many observers that Indonesia will remain prone to the same sort of unrest that forced former President Suharto from power in May, 1998. As investors flock back to Southeast Asia's other economies, says a U.S. investment banker, "Indonesia is absolutely off everyone's map."

Indeed, numerous deals needed to get the economy moving again remain frozen. Chief among them is the government's $123 million sale of Bank Bali to Standard Chartered Bank. That transaction was supposed to begin the flow of badly needed foreign funds into the banking system. But talks have been in limbo since an audit found that the ruling Golkar party had illegally channeled $80 million in Bank Bali funds into Habibie's reelection campaign.

The Bank Bali mess looms over Indonesia's future almost as darkly as the army. After sacked CEO Rudy Ramli named seven ministers in an inquiry, Habibie made them immune from prosecution by giving them appointed seats in a national assembly. A report by PricewaterhouseCoopers, obtained by BUSINESS WEEK, warns of the "high vulnerability to internal and external fraud" within the Indonesian Bank Restructuring Agency (IBRA), which oversees the banking cleanup. The affair "will have to be resolved before financial assistance can go on," IMF Deputy Managing Director Stanley Fischer warned in a seminar in Washington on Sept. 26. "It's a pity, because Indonesia was beginning to recover quite well."

Bankers in Jakarta now believe IBRA will fail to meet its $6 billion target on sales of seized assets from nationalized banks. That's money Jakarta needs to pay interest on bonds issued earlier this year. Indonesia has also announced that it will seek to reschedule more than $2.6 billion in foreign debt that is due to mature in the year ending March, 2001.

BEADS AND MACHETES. Indonesia can still avert another political and economic disaster. But it will have to move adroitly in the next few weeks. While a credible transition requires the army to signal that it is stepping back from politics, it's far from clear that Wiranto is contemplating such a move. What's more, Megawati has avoided criticizing Wiranto--even during the carnage in East Timor. Wiranto precipitated the current political crisis when he pushed the outgoing legislature to pass a security bill enhancing the executive's power to declare martial law. When clashes between protesters and police left at least seven dead, Wiranto advised Habibie to delay signing the bill into law. But it continues to hang in the air like tear gas after a demonstration.

An incident on Sept. 24 suggested that the army may be ready to use the same grim tactics in Jakarta as it applied in East Timor, where army units out of uniform masqueraded as rogue militias.

In the capital last week, some 2,000 men dressed in white Islamic robes marched on parliament--each with prayer beads in one hand and a machete in the other. Given that they moved freely despite a heavy military presence around the city, Asian diplomats say, it's likely that they were, as in Timor, disguised Indonesian soldiers deployed to sustain an already palpable air of menace.

If parliament's indirect presidential election goes forward and a stable civilian administration is in place, it would take about six months before investors would make new commitments, predicts Avi Y. Dwipayana, president of Trimegah Securities in Jakarta. But as the clouds of another terrible political storm gather over Jakarta, that seems like a very big if.