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Indonesia:
An Economy in Transition
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A project by: Zara Ahmed, Julia Dreier and Frank Ro
Overview:
• Indonesia: A Brief History
and Crisis
a
• OverviewQuickTime™
of the Asian Financial
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• Causes
of the Crisis
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•are
Indonesia’s
Response
the Crisis
• Why Initial Reforms May Have Failed
• Indonesia Post-Crisis
• Potential Future Steps
Indonesia
•17,500 islands, 200 million people
•GDP: US$935 billion
•GDP Per Capita: US$3800
•Unemployment: 12%
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Indonesia
•Population Below Poverty Line:
17.8%
Indonesia: A Brief History
• 1945: Political instability and a deteriorating
economy
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1960s: New Order Administration:
inflation
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comes down, foreign debt becomes
aremanageable,
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picture.
problems begin to arise with
oversight and regulation
• 1980s and 1990s: foreign investment
increases, GDP grows
Indonesia’s Per Capita GDP and
GDP Growth Rate
The Asian Financial Crisis
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• Large investment
flow into Indonesia
and other East
Asian countries
• U.S. raises interest
rate
• In early 1997, Thai
baht is devalued
The Asian Financial Crisis
(1)
(2)
(3)
(4)
(5)
(6)
Investors expect devaluation of the rupiah, due the
increasing value of the US dollar and what occurred
in Thailand.
Reluctance to borrow: because loans will have to be
repaid in more valuable dollars the IS curve shifts
inwards.
Fall in invest: depresses planned expenditure, which
in turn depresses income from Y1 to Y2
The fall in income, which decreases money
demanded
The reduced demand in money reduces the nominal
interest rate
The nominal interest rate falls below the expected
deflation, thus the real interest rate raises.
The Asian Financial Crisis
Interest Rate
LM
0
Real
Equilibrium
Nominal
Expected
Deflation
IS1
Y1
Y0
IS0
Y=Output
Causes of the Crisis--Domestic
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• Large external deficits
• Inflated property and stock
market value
• Corrupt government
• High-risk lending--non
performance loans
• Wealth concentrated in the
hands of a few banks
• Pegged exchange rate
Causes of the Crisis--International
• The Mexican Peso
Crisis
• The U.S. Federal
Reserve raised
interest rates
• Currency speculation
in Thailand,
Malaysia, and other
East Asian countries
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Indonesia’s Response to the Crisis:
Initial Responses
• Widened the pegged exchange rate from 8%12%
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• Raised interest rates
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• Floated the exchange rate
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• Reduction of government spending
Indonesia’s Second Response to the
Crisis--The Five Point Plan
• Stabilize the rupiah at a new equilibrium level
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• Strengthen
the fiscal policiesand
and fiscal
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•are
Reduce
the current
account
• Support the banking sector
• Reassure the private sector about the stability
of the economy
IMF’s Response to the Crisis
• IMF loans to Bank
Indonesia
• An agreement to a
balanced budget or surplus,
maintain high nominal
interest rates and restrict
domestic credit
• Restructure financial
markets
• Adopt good governance
reforms and improve
oversight
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Implementing IMF Reforms
• Indonesia’s proposed budget included a
deficit instead
of
a
surplus
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•
IMF
claims
that
Indonesia
was
not
serious
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about reform
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• Creation of the Indonesian Bank
Restructuring Agency
Interpreting Indonesia’s Response
Using the IS-LM Model
If Y= C(Y-T)+ I(r)+ G+NX(e)
The government succeeds in raising the interest rate. However, two
major problems arise:
a)The GDP decreases substantially
b)While the interest rates increases, foreign investors still are cautious
about investing in the country.
(3)
The crisis worsens, investment deteriorates, consumption and
government expenditure would continue to decrease; thus, the IS curve
once again shifts inward towards IS2.
(4)
The Indonesian government continues to artificially increase the
interest
rates. Thus, they contract the money supply once again
(moving to R2 and BP2)
(1)
(2)
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(5)
Investors are still not enticed to invest with the even higher interest
rates. Again, GDP falls and this process continues until the government
realized that maintaining a fixed exchange rate was not going to work.
Interpreting Indonesia’s Response
Using the IS-LM Model
Interest rate
Interest rate
LM2
LM1
LM0
R2
BP2
R1
BP1
R0
BP0
IS0
IS1
IS2
Y=GDP
Why the IMF Reforms Failed
• IMF cannot rally market confidence
• IMF publicly announced that Indonesia had deep
structural flaws
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• IMF believed
that reducing financial
be enough to reassure creditors
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• IMF
advocated
fiscal policy
are
needed
toa contraction
see thistopicture.
• Loan packages were not large enough
• Lengthy reform stipulations took up valuable
government resources
• Initial loan programs and agreements were not made
public
Indonesia Post-Crisis
• Democrat election of Susilo Bambang
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• Focus on improving access
to basic
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necessities to see this picture.
• Reduction of government’s debt ratio
• Improved fiscal management and banking
systems
Potential Future Steps
1. Continue to improve the Bank of Indonesia’s
transparency, independence, accountability, and
credibility
2. In order toQuickTime™
maintain market
and aconfidence and
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attract
additional foreign
investment, continue to
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invest
local programs
create a more stable
infrastructure and aid in the development of
human capital
3. Increase tax revenue
4. Continue to reduce the debt to GDP ratio
Questions?
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