Causes of the Indonesian Financial Crisis
When the financial crisis hit Asian countries in mid-1997, Indonesia did not escape the impact. It became one of the worst hit countries during the crisis. The question to be answered is what really caused Indonesia, which at the time had a magnificent economic growth to collapse along with most of Asian countries. This paper studies the factors that may be causing the crisis and how the combination of them could lead to such crisis.
Indonesia’s Economy before the Crisis
* Indonesia under the governance of President Suharto was considered a growing and vastly developing country, with a 7.9% growth in GDP in 1996. GDP per capita first surpassed ...view middle of the document...
Most of them were short-term loans; the total can be as high as US$85 billion to US$115 billion.
* Continuing excess demand. Account deficit increased from 1.6% in 1994 to 3.2% of GDP in 1995.
* Corruption within the government was high. Transparency issues in the government with several people especially the President's sons and daughters controlled many major companies in Indonesia.
* Weak legal and regulations for the financial system. Lots of unhealthy banks running on very low capital.
* Indonesian central bank (Bank Indonesia) had allowed rupiah to float with a range of 8% allowing a 4-5% annual depreciation from 1995. This band would later be increased to 12%.
The Asian crisis started on July 2, 1997 when the Thai government floated the baht from 25 to 35 per US$ triggering a contagion that spread throughout South East Asia.
To sum it up, Indonesia economy during the crisis fell due to:
* Pressure on the regional currencies initially did not hit Indonesia really hard, the large account deficit and foreign debt in US$ seemed to not affected Indonesia much. Indonesia also had allowed the currency to float within a band since 1995. When other regional currencies started to decline in 1997, Bank Indonesia increased the band to 12%. In August, rupiah fell below the 12% band. This forced the central bank to float the currency freely. This in turn caused panic among many companies with foreign debt denominated in US$.
* These companies had high amount of debt in US$ with a short due date, and most of them were rushing to pay, so they were selling rupiah for dollars further depreciated the rupiah. In October, the rupiah was at 3500 for a US$1. (exhibit 3)
* It is indicated that amount of debts around this time were higher than initially thought. The non-transparency of the economy as well as the numerous cases of corruption and “cronyism” and favoritism to close friends of the President’s family may be contributing to the sham of these debts.
* Further depreciation of the rupiah caused dollars to be more expensive to purchase. Lots of developments projects were halted since the supply chains were also paid in foreign currency.
* Many companies in the financial sectors defaulted, including banks, leading to the imminent collapse of banking sector. The government liquidated 16 private insolvent domestic banks in November, causing a massive decrease of confidence in the banking sector.
* Bank rush occurred causing banks already in short capital to...