FINANCIAL CRISIS IN INDONESIA:
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FINANCIAL CRISIS IN INDONESIA: Problem, Solutions, and Lessons. FISKARA INDAWAN Econ 522, Spring 2007 May 1, 2007 University of Illinois, Urbana-Champaign. Outline. The root of financial crisis in Indonesia Why Indonesia had the worst crisis? What was the policy response for the crisis?

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FINANCIAL CRISIS IN INDONESIA: Problem, Solutions, and Lessons

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FINANCIAL CRISIS IN INDONESIA:

Problem, Solutions, and Lessons

FISKARA INDAWAN

Econ 522, Spring 2007

May 1, 2007

University of Illinois, Urbana-Champaign


Outline

  • 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


The root of financial crisis in Indonesia

  • 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 1980s-1990s cheap fund from abroad.

  • However, there were no official figures about foreign borrowing by private sectors source of shock for fixed exchange rate regime.


Why Indonesia had the worst crisis?

  • Financial crisis in Indonesia a multi-faceted 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.


Why Indonesia had the worst crisis?

  • 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.


What was the policy response for the crisis?

  • 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).


What was the policy response for the crisis?

  • 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.


What was the policy response for the crisis?

  • 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.


What lessons can be drawn from the crisis?

  • 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.


Conclusion

  • 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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