Indonesia Post 1998 Crisis
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Published: Wed, 04 Oct 2017
- Aing Fnu
- Andry Sjamsu
- Ari Mulyono
- Ivan Edgar
- Karly Mulyadi
- Mikhael SP Butar Butar
- Ridwan T Lembong
Prior to the 1997, Indonesia was in its best financial condition. Indonesian economy represented one of East Asia’s major success stories of economic structural transformation. The economy grew on average by 7.6 percent from 1967 to 1996. Structural transformation took place in agriculture, manufacturing, utilities, and services. In line with high economic growth and structural transformation in several sectors, the poverty rate declined from around 40 percent (54.2 million people) in 1976 to 17.5 percent (34 million people) in 1996. Together with Malaysia and Thailand, Indonesia was classified as a member of the second tier of Newly Industrialized Economies (NIEs).
However, the Asian Financial Crisis in 1997/1998 reversed the situation completely. Indonesia experienced its worst financial period during the Asian Financial Crisis. Many banks were very weak and had made bad loans. Indonesia consequently saw a massive lending boom in the run-up to the 1997 crisis. The Loan-to-Deposit Ratio (LDR) was more than 100 percent in 1997, and the ratio of non-performing loans (NPL) to total credit was around 27 percent in September 1997. The Asian Financial Crisis started on 2 July 1997 when the goverment of Thailand, burdened with a huge foreign debt, decided to float its baht after currency speculators had been attacking the country’s foreign exchange reserves. The pressures then continued to other Asian countries as well.
The fixed exchange rate system, which was adopted by Indonesia before 1997, helped to precipitate the financial crisis. As it became too expensive to fend off speculators, currencies were forced to float freely starting from August 1997. Indonesia started to implement free floating system. This resulted in large falls in the Rupiah against the US dollar. From an average of Rp2,342 to the US dollar in 1996, the Rupiah fell to an average of Rp10,014 in 1998. The depreciation of Rupiah continued to exacerbate the situation drastically, so that later there was an explosion of debt from local private companies which had short-term loans in the US dollar since before 1997.
THE INDONESIAN ECONOMY: FROM ITS BEST, TO ITS WORST
How did a country with financial success story and known worldwide to have the strong economic fundamental eventually participate in Asian Financial Crisis? The answer could be seen from 2 perspectives: Financial Sector and Political Sector.
- Foreign Debt Problems
Large number of short term private foreign debt stock created instability. Companies which had received large unhedged foreign-currency loans faced impossibly high debt repayments in domestic-currency terms.
In line with that, Indonesian goverment did not have a supervisory mechanism for the debt created by the private sector in Indonesia. Financial market was inherently unstable which then led to the economic bubble and tended to run wild.
- The Weakness in Banking System
Rapidly growth of industry in the banking sector was not followed with proper supervision and control on banking system, which was resulted in ineffective control from the government and negative banking environment. A lot of banks were still allowed to operate without having capital adequacy (undercapitalized) and strong operating system, which caused the tracking of loans was not recorded properly.
Due to the weakness in banking system, the problems of external private debts, which Indonesian government did not have a mechanism to control, instantly turned into the problems of domestic banking. Many banks were no longer able to withstand the financial situation, and finally on November 1997, Indonesian government liquidated 16 private domestic banks, which was followed by the merger of few banks, but in fact it did not make the situation better.
People’s actions to force Suharto stepping down from the throne of his presidency and to end his regime, had to be paid by great sacrifice in the form of chaos which resulted the capital owners and investors fled from Indonesia. There was panic in national political economy marked by the massive capital flight (flight for safety). This kind of capital flight was greater than the one triggered by economic considerations (flight for quality).
THE IMPACT OF FINANCIAL CRISIS ON THE INDONESIAN ECONOMY
The Asian Financial Crisis, which hit in 1997/1998, was the worst financial “storm” compared to what happened before in 1970s and 1980s. This financial crisis had devastating effect on the Indonesian economy and caused the economic contraction of 13.7 percent. The exchange rate became serious problem. From early July 1997 to 1998, the Rupiah weakened against the US dollar from Rp2,500 to Rp10,000, and reached its peak at Rp17,000. At the same time, the inflation jumped to 70%.
The negative impact of inflation and the increase in food prices caused the number of poverty increasing substantially. The number of people living below the poverty line rose from 15.7 percent in February 1997 to 27.1 percent in February 1999. The unemployment rate rose from 4.7 percent in August 1997 to 5.5 percent in August 1998, while underemployment increased from 35.8 percent to 39.1 percent.
HOW DID INDONESIA REACT?
The reaction of Indonesian government to end the crisis was by working together with International Monetary Fund (IMF) on how to restore market confidence. However, the lack of the nation’s trust against the president reflected the concerns about the future political uncertainty in Indonesia. The financial crisis had fully grown into social and political issues. Presiden Soeharto, who continued to maintain his authority by refusing to follow IMF’s advice in the reduction of subsidies, finally gave up to the people’s fierce desire to step down from the throne.
A new political system led by new Indonesian president, B.J. Habibie, was a starting point of the crisis recovery. An agreement with IMF, which was signed in June 1998, allowed the budget deficit to extend further while new funds were pumped into the economy. Then within few months, there were some signs of recovery:
- The Rupiah began to strengthen to Rp8,000 against the US dollar.
- Inflation declined significantly.
- The stock index started to rise.
- Non-oil exports revived.
Since that time, Indonesian economy recovered gradually shown by GDP growth in 1999 compared to 1998 (see Figure 1).
Figure 1 – Gross Domestic Product (GDP) Growth in Indonesia during 1996-1999
ACHIEVEMENTS AND FUTURE CHALLENGES
Indonesia had learnt a lot of lessons from the 1997/1998 financial crisis, and as result, Indonesia now has better and stronger economic, social, and political fundamental which is shown by:
- Healthy capital adequacy and maximum limit of credit in banking industry to prevent the liquidity problem happened in 1998 to re-occur. Now Indonesia has higher capital adequacy ratio in banking sector (Reuters 2012).
- The ability of Indonesia to manage the financial crisis in 2008 based on a number of lessons from what went wrong in 1998, so that the impact of the 2008/2009 Global Financial Crisis on Indonesia economy was relatively limited compared to other ASEAN countries. In other words, the 1997/1998 Asian Financial Crisis helped the country to survive from the 2008/2009 Global Financial Crisis.
- The improvement of law enforcement towards corruption with the establishment of Komisi Pemberantasan Korupsi (Corruption Eradication Commission), a government agency established to fight corruption. The 1998 financial crisis stimulated the awareness of many Indonesian people that corruption must be eradicated to restore people trust and support towards government policies.
- The social and political stability to attract foreign investors to invest in Indonesia.
The future challenges for Indonesia are:
- Maintaining fundamental stability
Indonesia has to be able to maintain its fundamental stability to avoid future crisis and achieve 7% GDP growth as stated by current Indonesian President, Joko Widodo. In order to achieve that, Indonesia needs investors to come and invest in Indonesia, mostly in infrastructures sector and other long term investments.
- Improving human resource quality
Indonesia has to be able to improve its human resource quality through education, health, and mental revolution which had already been stated by President Joko Widodo as his national priority programs.
- Introducing and improving prudent and strategic long-term national policies
These national policies have to be prioritized in financial sector, especially in banking and trading.
- Giving more attention to several major hurdles in the future
In the coming years, Indonesia has to be able to deal with:
- Government-party relations
- Infrastructure development
- Continuous fighting against corruption
It takes continuous commitment and decisive actions from the government and people of Indonesia to fight against corruption, which will result in the trust from the market and the investors.
- Increasing the volume of non-oil export
In order to reduce the dependency on domestic demand, Indonesia has to be able to increase its non-oil export volume and find the new export markets based on its competitive advantages.
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