Indonesia is staggering like a heavyweight boxer who has absorbed too
many blows in too many places. A faltering economy, a fractious and
feeble central government, communal war and secessionism could
culminate in the state's collapse and the country's fragmentation.
The result would be more than a local disturbance, for Indonesia is
no ordinary place.

With 224 million people Indonesia is the world's fourth most populous
state, a sprawling archipelago of 13,600 islands (3,000 of them
inhabited) nearly three times the size of Texas. While 87 percent of
its citizens are Islamic (no country has more Muslims), Indonesia is
a kaleidoscope of nationalities, tribes, languages and dialects. The
sea lanes that cut through this island constellation--the straits of
Malacca, Sunda and Lombok--connect the Asia-Pacific to Europe and the
Persian Gulf, bringing the lifeblood of energy and raw materials and
providing an outlet for its manufactured exports. Now that
globalization has diminished the distinction between "there" and
"here", the disruptions that East Asia's largest economies would
suffer if shipments are blocked or delayed will reverberate
worldwide. Indonesia is also a fragile democracy in trouble and a
humanitarian disaster-in-waiting that threatens to upend the
strategic circumstances of Southeast Asia. Obviously, then, the U.S.
stake in Indonesia's future is enormous.

The Political Economy of Chaos

The 1997 East Asian economic crisis illustrated globalization's power
as both opportunity and vulnerability--this everyone by now
understands. What remains unclear is why Indonesia alone has been
rocked to its foundations when every other Asian country hurt by the
1997-98 crisis has recovered its balance to one degree or another.
The basics of its economy were sound, and for nearly three decades
Indonesia experienced an economic and social transformation that
bettered the lives of most of its people. Between 1970 and 1997 the
percentage of those in poverty fell from 60 percent to 15 percent,
life expectancy and literacy increased significantly, and an urban
middle class arose. Revenue from oil exports enabled the expansion of
infrastructure and social services, and the share of GDP accounted
for by the production of natural resources then shrank as
industrialization advanced. Non-Javanese peoples in outlying areas
and students, workers, and democrats chafed, the disparities in
wealth and power among classes and regions were wide, and cronyism,
nepotism, and corruption were rife. But the "New Order" (the
authoritarian edifice Suharto built after taking power in 1965)
promoted growth and kept order.

The 1997 economic crisis was its death knell. Indonesia's GDP
plummeted from $250 billion to below $100 billion at the end of 1998,
and inflation rocketed to 60 percent. Capital fled abroad, millions
were pushed deeper into poverty, and the dreams of others whose lives
had improved during the decades of rapid growth were dashed. The
absence of democratic institutions led simmering dissatisfaction to
boil over onto the streets.

Political consequences soon followed. Suharto was forced out in May
1998, and his successor, B.J. Habibie--ineffectual and compromised by
his long association with Suharto--proved a political hiccup. In
October 1999, following parliamentary elections, Indonesia's highest
legislative body, the People's Consultative Assembly (MPR, the
Mejelis Permusyawaratan Rakyat, comprising the 500-member parliament
plus representatives from the military, the provinces, and civic
organizations) elected Abdurrahman Wahid president, and, after Wahid
nominated her, chose Megawati Sukarnoputri as vice president.

Something like a democracy emerged. But the change accelerated
instability. Indonesia's non-Javanese minority peoples saw an opening
to assert their rights. East Timor broke free, but not before being
brutalized by the Indonesian armed forces and its paramilitary
acolytes. Long-established separatist movements in Aceh and West
Papua (Irian Jaya) have gained confidence and new converts. Maluku
and Sulawesi are now venues for horrific violence between Muslims and
Christians. Kalimantan's Dayaks and Malays have set upon settlers
from Java and Bali, forcing survivors to flee. Lombok and Riau have
also experienced unrest. These upheavals have saddled Indonesia with
a million internal refugees that local governments struggle to house
and feed as the hospitality of permanent residents gives way to
resentment. Indonesia's descent into communal violence included
anti-Chinese riots (pogroms would not be too strong a term to
describe them), which accelerated the flight of capital, for ethnic
Chinese, while only three percent of the population, control almost
three-quarters of Indonesia's wealth.

Indonesia's odds for survival would be increased by a broad economic
recovery that attracts capital back into the country and that gives
people in rebellious regions a stake in national unity. There are
some encouraging signs. The economy, which contracted by 15 percent
in 1998, stabilized in 1999 and grew by five percent in 2000.
Inflation, which stood at 60 percent in 1998, dropped to just below
seven percent in 2000. The flight of capital fell sharply, foreign
exchange reserves amounted to $22 billion in 2001, domestic
investment has picked up, and exports have grown. And the
International Monetary Fund is on hand with advice and $5 billion in
loans, though not a few Indonesians are leery of its standard
cures--and who can blame them?

But this sliver of a silver lining frames a large dark cloud.
Indonesia's banks and companies bear an external debt of $65 billion,
but corporate restructuring and reform proceed at a snail's pace. The
tepidity of reform explains why Indonesia ranks second worst in the
Asia-Pacific in the quality of corporate governance and third worst
in transparency. These dubious honors have hardly increased business
confidence: ING Barings has warned investors away from Indonesia (as
well as Malaysia and Thailand); Standard and Poor's revised
Indonesia's creditworthiness downward sharply.

Meanwhile, the steps that the Wahid government took to devolve power
to the provinces, essential to keep Indonesia whole, may heighten
investors' concerns. As of January 2001, provinces and districts keep
80 percent of mining, forestry and fishing revenues and 15 percent
and 30 percent respectively of natural gas and oil income and also
have rights to borrow independently. Western mining and energy
companies, already facing demands from provincial authorities for a
share of equity, worry about a profusion of power and corruption
unmatched by competence, conflicting lines of authority, increased
taxation by local authorities, and additional twists in an already
labyrinthine legal system. Mining companies are particularly loath to
make new investments, and their mood could influence other
corporations. For their part, the IMF and the World Bank fret that
provinces will be profligate with their newfound freedom to borrow.

Nor is Indonesia's outlook positive when gauged by the standard
economic indicators. The projected GDP growth rate for 2001 has been
revised down to 3.5 percent from 5 percent. Actual growth could be
even lower if political ferment continues. The national debt is about
as large as the size of the economy. The budget deficit is 6.5
percent of GDP, and the IMF wants it cut to 3.5 percent. The
government announced deep cuts in subsidies for electricity and oil
in 2001 to achieve the goal, but the frailty of the central
government may make further stringency infeasible. Without a smaller
budget deficit, inflation, 6.8 percent in 2000, is expected to reach
8.5 percent or worse by the end of 2001. The rupiah, which stood at
6,800 to the dollar in 1999 (about a third of its value in 1996),
fell to 11,000 in early 2001 and reached 12,000 in May, the lowest
level in almost three years. Its descent makes deficit reduction
harder still and could also stoke inflation. Indonesia's reserves of
$22 billion look impressive, but that sum is insufficient to defend
the faltering currency. Interest rates could be raised to support the
rupiah, but that would increase the government's interest payment on
the debt. These discouraging signs have not escaped investors.
Capital outflows, while far smaller than in 1998, were still $4
billion in 2000. New foreign direct investment, $10 billion in 1996,
has essentially ceased, as has portfolio investment.

Nor do global economic conditions augur well for Indonesia's
recovery. Economic growth in America, a major market for Indonesia's
exports, is slowing. Japan, another important customer and the key
source of direct and portfolio investment, is in far deeper trouble;
its corporations have canceled new investments in Southeast Asia and
laid off workers in Indonesian subsidiaries. Europe cannot take up
the slack, while China is a major competitor to Southeast Asia for
foreign investment and exports. If the global economic slowdown
reduces oil prices, Indonesia's treasury will lose $50 million for
every one-dollar drop; deficit reduction will then be harder still
and inflation could rise. Indonesia's convulsions cannot be reduced
to economic causes, but they will prove impossible to manage, let
alone cure, if the economy deteriorates further--and despite the
brave front of Indonesian officials, the economic outlook is bad.

Family Feud

In Indonesia, as elsewhere, communal conflict accompanied the state's
attempt to create national unity from ethno-linguistic diversity.
Heterogeneity typifies Indonesia, even when it comes to Islam.
Indonesian Islam has many doctrinal and regional variations, so it
both unites and divides. Buddhists, Christians, Hindus and
animists--and a mosaic of languages and dialects, tribes and
nationalities--add to the multiformity, which sharpens its political
edge on the stones of geography. The separation imposed by a
scattered multitude of islands has fostered separateness and has been
the ally of exterior areas to whom the central government in Jakarta
is the distant symbol of Javanese dominance. This is well illustrated
by the case of Aceh, on the northern tip of Sumatra, which now
presents the biggest challenge to Indonesia's territorial integrity.