The floating of the Thai bath in July quickly put pressure on the Indonesian rupee as it was perceived by investors as facing similar weaknesses that cast doubt on their credit-worthiness, and by October, the rupee had been floated. The impact of this was that the rupee had depreciated by 30% by October 1997, as ‘hot money’ flows moved to countries with higher rates of return, like the UK. The reason for this ‘hot money’ selling its Indonesian currency and buying Pounds or Dollars was that the Indonesian government had been forced to decrease interest rates in its monetary policy to try and stimulate growth. This not only had the effect of causing movements of ‘hot money,’ it also produced a greater inflationary pressure.
On November 5, the Indonesian government entered into a three-year stand-by arrangement with the IMF for US$ 10 billion to try and boost the exchange rate and to keep banks from insolvency. Large amounts were also pledged by other multilateral institutions ($8 billion) and by bilateral donors ($18 billion). Although the rupee initially appreciated, market confidence soon began to fall again after sixteen insolvent banks were closed by Bank Indonesia in November. This fall in consumer confidence caused people to save their income instead of spending it, this caused a decrease in total consumer spending that led to a downward multiplier effect. The choice to invest instead of to spend would have had an opportunity cost associated with it. This fall in consumer spending had an impact on lowering GDP. Business confidence also decreased, causing a further decrease in investment demand that also had an impact on lowering GDP.
By end-July 1998, the rupee had fallen by about 65 percent relative to end-1997. The loss of confidence sparked financial instability, and output collapsed, with a severe impact on the poor as inflation rose.
The impact of the Asian financial crisis had large social costs. Prices for food items went up faster than prices of non-food items. This made the impact harsher on the poor and a reduction in consumption was widespread.
The social costs to Indonesia were higher official crime rates, possibly causing an increase in government spending to sort the problems out, and long-standing ethnic tensions that erupted into open violence and political instability, causing the downfall of the President.
By the end of 2000, the Indonesian economy had recovered significantly. It currently has positive GDP growth (a 4% increase in 2000), and increasing political stability has created a return of confidence to the markets and banking sector. A new three-year extended arrangement for about US$ 5 billion was made with the IMF in February 2000. The macroeconomic framework will have restored an annual growth rate in the vicinity of 5 to 6 percent by 2002, a growth of about 1-2% from 2000, with an annual inflation target of below 5 percent. The government established the Financial Sector Policy Committee in 1999 with the mandate to provide leadership and direction in banking and corporate restructuring. One reason for the Asian financial crisis was bad decisions made by banks in offering loans. By introducing what was essentially a watchdog, this problem could be avoided in the future. Other objectives of the Financial Sector Policy Committee were enhancing efforts to restructure state banks and ensuring better governance and supervision of the banking sector for the future.
The Indonesian economy is recovering now whilst inflation remains low and stable. This was achieved by a tight monetary policy in controlling interest rates. GDP grew by 5.8 percent in the last quarter of 1999 relative to the same period of the previous year, enabling a small positive growth in calendar 1999. Increasing consumer consumption and the resulting de-stocking by businesses continue to be the main engines of the emerging recovery. Inflation has continued to be virtually flat since June 1999 as the exchange rate stabilised, and interest rates have been brought back to pre-crisis levels.
In Indonesia, political turmoil and poor policy implementation impeded recovery, but the economy is now growing comfortably although the impact of the expected US recession could bring forth new problems to the economy. Another depreciation of the US$ could cause another attack on the East Asian countries currencies, but by now they are more aware of the problem and can act faster than they did in 1997. Problems before the crisis, such as flaws in the banking sector have now been addressed, and any further crisis would not be so severe.
Another indicator of the Indonesian economic recovery has been international companies seeking to capitalise on the downturn by purchasing parts of, or whole businesses at low prices, in order to expand their operations in the region. This also led to an increase in output in the area, increasing employment (therefore creating a multiplier effect) and increasing business investment, and maybe most importantly, confidence in the markets. As a result, overall spending increased and the economy began heading for stable, sustained growth.
Conclusion.
The Asian financial crisis caused the Indonesian economy to go into a recession. The economy suffered falling GDP, rising inflation and a fall in consumer and investment demand. Companies faced falling profits or losses and many were forced into receivership. The banking sector was especially hard hit as sixteen banks went insolvent. In comparison to the rest of East Asia, Indonesia fared the worst, although Thailand also experienced severe problems. The economy has now recovered to a modest but stable growth rate, with inflation under control. Indonesia and the rest of the ‘Tiger’ economies have learnt that high growth of an average of over 8% is not sustainable, and that over 5% is still very risky. Whether these economies will take the steps necessary to ensuring that this will not happen again has yet to be seen, but by risking high growth, they are heading down the same path. Under guidance from the International Monetary Fund, the Indonesian economy should be kept stable and previous problems addressed. The emerging US recession will impact heavily on the Indonesian economy, but it should be able to exploit increasing internal demand and continue to grow.
The future to Indonesia’s growth and prosperity is investment as well as fixing the problems before the crisis. Through investment, businesses can increase aggregate supply; become more efficient and therefore cut costs. Through these changes, the Indonesian economy should be able to continue to be prosperous whilst much of the world is in recession. However, the country must watch too high growth that is unsustainable and take the necessary action.
Appendix 1.
A number of graphs to show the gross domestic product values from 1996 to 2000 for Korea, Thailand and Indonesia.
Sources: Indonesian authorities and International Monetary Fund staff estimates.
These graphs show that from 1996 to 1998, Indonesia, Korea and Thailand have all experienced a slow down in their GDP levels. In all three countries in 1998, the growth of their GDPs actually decreased. The average annual high of 8-10% of the previous growth period was brought right down to lows of –14.2% in Indonesia and –10.2% in Thailand in 1998. These figures show that 1998 was the worst year overall for all three countries, and that Indonesia was the hardest hit. The decrease in GDP was caused by a number of factors including a decrease in consumption and investment demand.
Appendix 2.
Sources: Indonesian authorities and International Monetary Fund staff estimates.
These graphs show that Indonesia increased its levels of debt considerably from 1996 to 1998, a rise from $127.4bn to $149.9bn. This was due to the loans generated from the IMF other multilateral institutions and by bilateral donors. These loans appear to have had a beneficial impact, because although total external debt had stayed roughly the same from 1997 to 2000, debt as a percentage of GDP fell sharply. This points to an increase in GDP partly as a result of these loans.
Appendix 3.
This graph shows that if aggregate supply decreases from AS to AS1 as a result of falling GDP, then price levels will increase from P to P1 unless aggregate demand falls. However for this to happen, businesses would have to scrap capital, and this is unlikely to happen, but it is a warning for the future if investment does not pick up. Also, aggregate demand did fall as consumer saving increased.
A more likely scenario is that large decreases in the exchange rate causes imports to rise in price. If these goods have a low price elasticity of demand, then the fall in the exchange rate would cause increased costs to businesses, and therefore increase inflationary pressure.
However, the correction of the depreciation would mean that the demand for exports would increase, as they are less expensive. This increase is shown below in appendix 4.
Appendix 4.
Sources: Indonesian authorities and International Monetary Fund staff estimates.
This graph shows that between 1996 and 1997 the government had a current account deficit, but by 1998, the depreciation of the rupee had allowed exports to increase, whilst imports remained roughly the same, causing an inflationary pressure.
Appendix 5.
Sources Bloomberg, WEFA, INS and IMF.
These charts show select economic indicators for Indonesia and other East Asian countries. In each graph, Indonesia has been most affected; backing up my assertion that Indonesia was the hardest hit.
Bibliography.
Nuffield’s Economic and Business Student book, published by Longman.
The Asian crisis:
Globalisation and Patriarchy in Symbiosis, www.dawn.org
The Economist:
November 7th 1998 – Asia and its foreign investors.
November 14th 1998 – Indonesia’s bank restructuring.
January 16th 1999 – Asian governments borrow again.
February 13th 1999 – China’s financial troubles.
March 13th 1999 – Asia’s property woes continue.
March 20th 1999 – Indonesia’s Robin Hood.
Barclays Economic Review, second quarter 2001.
‘Sick Tiger Syndrome’ Business Review, September 1998.
IMF Asian Crisis Report – 1998, www.imf.org
Financial times website – www.ft.com
Articles in - Asian Financial Markets/Markets:
Equity Capital Markets.
Optimism over improved conditions is premature.
See appendix 1, a number of graphs to show the gross domestic product values from 1996 to 2000 for Korea, Thailand and Indonesia.
See appendix 3, reasons for an increase in inflationary pressure.
See appendix 2, a number of graphs to show the level of debt for the Indonesian government.
2See appendix 1, a number of graphs to show the gross domestic product values from 1996 to 2000 for Korea, Thailand and Indonesia.
See appendix 3, reasons for an increase in inflationary pressure.
See appendix 1, a number of graphs to show the gross domestic product values from 1996 to 2000 for Korea, Thailand and Indonesia.
See appendix 5; select economic indicators to show the changes in the exchange rate.