Halim, Reviving the Indonesian Banking Sector: Indonesia’s Economic Crisis: Impact on Financial and Corporate Sectors 1997-1999 | Indonesian Rupiah | Banks

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  This study’s objective is threefold. First, to investigate the impact of the current economic crisis on the Indonesian financial sector. Second, to relate how the previous financial policies had contributed to this financial blunder. And third, to discuss and analyze the financial reform efforts in response to the crisis.
  VISITING RESEARCHERS SERIES NO. 7(2000) Reviving the Indonesian BankingSector? Indonesia’s Economic Crisis: Impact on Financial and Corporate Sectors 1997-1999  Liliana Halim  VISITING RESEARCHERS SERIES NO. 7(2000) February 2000 Reviving the Indonesian BankingSector? Indonesian’s Economic Crisis: Impact on Financial and Corporate Sectors 1997-1999  Liliana Halim ISEAS Visiting Research Fellow(World Bank-East Asian Development Network Fellowship)March-June 1999  © 2000 Institute of Southeast Asian StudiesISSN 0219-3582  REVIVING THE INDONESIAN BANKING SECTOR?  INDONESIA’S ECONOMIC CRISIS: IMPACT ON FINANCIAL AND CORPORATE SECTORS 1997-1999 Abstract This study’s objective is threefold. First, to investigate the impact of the currenteconomic crisis on the Indonesian financial sector. Second, to relate how theprevious financial policies had contributed to this financial blunder. And third,to discuss and analyze the financial reform efforts in response to the crisis.There were many different factors acting simultaneously to bring aboutthe downfall of Indonesian economy, both external and internal, which thispaper touches on briefly. However, the impact of external factors such asspeculative attacks and regional currency imbalances could have beendampened if the domestic financial system was strong. This study discusses thefinancial policies that contributed to the weaknesses in the financial sector, towhich the financial system was unable to respond effectively from thebeginning of the crisis in July 1997. Thus, this paper is an inward-looking,retrospective effort, rather than focusing on the external causes of the crisis.After the July 1997 financial turmoil in Thailand, the contagious effectrolled over to other countries, and this was due to the increasingly large inter-linked derivative transactions in the region. But the impact on the Indonesianeconomy was so severe that it was even precipitating the collapse of the socialand political fronts, and a creating vicious circle in the economy.Prior to the crisis outbreak, the macroeconomic indicators were stronglypositive: high and constant economic growth, large capital inflows, highdomestic savings rate, and liquid and plentiful foreign exchange reserves.However, some signs of “growing risks” emerged over the past few years, andthese came in the form of growing imbalances: deficits in the current account,rapid expansion of commercial bank credit, and growing foreign debt. There,too, were non-economic key issues which, instead of serving as the underlyingstructural foundation, inflicted severe damage to the Indonesian economy andincreased its vulnerability. Such issues include legal inconsistency, lack of transparency, corruption, collusion, nepotism, inadequate supervision, lack of independence of the central bank, not to mention the political issues such as acentralized political system, and problems of succession and transition.The failure to overcome the initial pressures on the currency’s exchangerate was manifested in the drastic changes in the following indicators: largedeficits, property and stock market crashes, deteriorating banking system andcorporate bankruptcies — all of which subsequently drove the country intoeconomic and political instability. Aside from the still unstable political  2situation in the country, the government, together with internationalorganisations like the IMF, World Bank and ADB continued to carry outfinancial reforms. The current core issue is the banking system, because of itsclose connections with the corporate and the real sectors and its important roleas financial intermediary.Despite the extension of the financial liberalisation in the past, severalproblems with the banking-related institutions were not addressed. Some of these issues include lags in loan monitoring, inadequate banking regulationenforcement and legal certainties, monetary supervision, transparency reporting,creditworthiness criteria.The banking system, which is the backbone of the financial system, iscurrently under a recapitalisation scheme. The recapitalised banks are expectedto lead the financial restructuring and eventually, economic recovery. However,the prospect of this recapitalisation is still uncertain. How long it is going to getthe banking system ready for economic recovery would depend on thegovernment’s will and ability, the agencies concerned, the banking systemitself, as well as the development of the political situation. We have seen theIndonesian banking flourish during the past decade, and this crisis — if allrelevant parties responded positively — gives us the opportunity to see a reformthat could rejuvenate the financial sector, provide it with a more solidfoundation, higher value and quality. On the other hand, the situation canbecome worse if the above key issues in the financial sector are not addressedand if the socio-political situation fails to provide the necessary conditions foreconomic recovery. Introduction Since the outbreak of the Asian crisis, Indonesia’s economy has been the hardest hit, ascompared to those of other Asian countries like South Korea, Thailand, Malaysia andthe Philippines. Not only was the economic chaos fuelled by factors like the much-depreciated rupiah, the highly inflated prices and the halt of business activities; thefinancial crisis also threatened national security and integrity. In May 1998, it broughtdown the “New Order” regime that had been in power since 1965. Riots were rampantin many parts of Indonesia; racial and religious tensions rose, often with a politicalagenda behind the scene. This situation had turned the country from being one of themost attractive places for investment, to a worrying place for investors and fly-intravellers.Prior to the crisis, there were no clear signals of the possibility of an economiccrunch. Instead, the major indicators showed “flying colours” figures, makingIndonesia one of the most attractive investment destinations. International lenders werezooming in for the high interest yields from short-term lending to Indonesian private
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