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Indonesia: An Economy in Transition QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. A project by: Zara Ahmed, Julia Dreier and Frank Ro Overview: • Indonesia: A Brief History and Crisis a • OverviewQuickTime™ of the Asian Financial TIFF (Uncompressed) decompressor • Causes of the Crisis needed to seeto this picture. •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% QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. Indonesia •Population Below Poverty Line: 17.8% Indonesia: A Brief History • 1945: Political instability and a deteriorating economy QuickTime™ and a 1960s: New Order Administration: inflation TIFF •(Uncompressed) decompressor comes down, foreign debt becomes aremanageable, needed to see this 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 Quic kTime™ and a TIFF (Unc ompres sed) dec ompres sor are needed to see t his pic ture. • 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 QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. • 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 QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. Indonesia’s Response to the Crisis: Initial Responses • Widened the pegged exchange rate from 8%12% QuickTime™ and a • Raised interest rates TIFF (Uncompressed) decompressor • Floated the exchange rate are needed to see this picture. • Reduction of government spending Indonesia’s Second Response to the Crisis--The Five Point Plan • Stabilize the rupiah at a new equilibrium level QuickTime™ a • Strengthen the fiscal policiesand and fiscal TIFFconsolidation (Uncompressed) decompressor needed to see thisdeficit picture. •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 Quic kTime™ and a TIFF (Unc ompres sed) dec ompres sor are needed to see this pic ture. Implementing IMF Reforms • Indonesia’s proposed budget included a deficit instead of a surplus QuickTime™ and a • IMF claims that Indonesia was not serious TIFF (Uncompressed) decompresso about reform are needed to see this picture. • 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) QuickTime™ and a F (Uncompressed) decompressor are needed to see this picture. (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 QuickTime™ and acorruption would • IMF believed that reducing financial be enough to reassure creditors IFF (Uncompressed) decompressor • 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 QuickTime™ and a Yudhoyono FF (Uncompressed) decompressor • Focus on improving access to basic are needed 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 TIFF (Uncompressed) decompressor attract additional foreign investment, continue to areinneeded to see thisthat picture. 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? QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture.