FINANCIAL CRISIS IN INDONESIA:
Problem, Solutions, and Lessons
FISKARA INDAWAN
Econ 522, Spring 2007
May 1, 2007
University of Illinois, Urbana-Champaign
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Outline
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The root of financial crisis in Indonesia
Why Indonesia had the worst crisis?
What was the policy response for the crisis?
What lessons can be drawn from the crisis?
Conclusion
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The root of financial crisis in Indonesia
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In the pre-crisis period, Indonesia received huge
capital inflows
external and internal
factors.
External factors: high sustainable economic growth
while most part of the world and industrial countries
showed stagnant growth.
Internal factors: financial liberalization in 1980s1990s
cheap fund from abroad.
However, there were no official figures about foreign
borrowing by private sectors
source of
shock for fixed exchange rate regime.
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Why Indonesia had the worst crisis?
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Financial crisis in Indonesia
a multifaceted crisis (so many events correlated
each other to make situation worsened).
At first the crisis was contagion effect from
Thailand.
GOI responded by floating Rupiah, delaying
big infrastructure projects, and closing
insolvent banks.
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Why Indonesia had the worst crisis?
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However, the policy could not calm the market
Rupiah depreciate by 36% & JSX plunged by 40%
private sectors could not serve their foreign
liabilities.
GOI asked IMF assistance.
Situation became worsened: renew attack on Korea,
GOI commitment to IMF program, and mature hugh
short term debt.
As a result, sharp depreciation of Rupiah until the
level of Rp17,000/USD in mid-Jan 1998 from
previously Rp2,100-2,500 since 1992.
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What was the policy response for the crisis?
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GOI had no choice but asking IMF assistance
to restore the confidence, and hence, the
economy.
Policy response to the crisis was mostly come
from letter of intent (LOI) highlighted by IMF.
Principal notion of IMF program:
“the enormous depreciation of the rupiah did not seem to stem from
macroeconomic imbalances, which remained quite modest. Instead,
the large depreciation reflected a severe loss of confidence in the
currency, the financial sector, and the overall economy” (LOI
01/15/98).
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What was the policy response for the crisis?
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IMF divided the program into 5 main parts, fiscal
policy, monetary policy, financial sector
restructuring, corporate restructuring, and structural
reforms.
Fiscal policy:
- increasing the revenue and reducing the spending.
- target: budget surplus 1% of GDP.
Monetary policy: tight money policy
situation worsened.
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What was the policy response for the crisis?
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Financial sector restructuring:
- Liquidate more insolvent banks.
- Merger and acquisition among banks.
- Strict rules on prudential banking (CAR, risk-based
supervision).
Corporate restructuring: set up Indonesian Debt
Restructuring Agency (INDRA) to restructure
corporate debt and established new bancruptcy law.
Structural reforms: privatisation, deregulation, and
trade and investment reforms.
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What lessons can be drawn from the crisis?
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Good governance must be the main prerequisite
for financial market liberalization.
A country must have a huge foreign reserves and
credible government to support fixed exchange
rate policy.
Government credibility is the key success to
restore the economy when a country has been hit
by financial or economic crisis.
In the global market, a country must have a strong
and sound domestic financial market.
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Conclusion
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Financial crisis in Indonesia: multidimensional crisis.
Main problem of financial crisis in Indonesia:
excessive foreign borrowing by the government and
private sectors.
The policy response came in the form of letter of
intent signed between Indonesia and IMF.
A country that adopted fixed exchange rate must
have a huge foreign reserves and credible
government policy.
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