INDONESIA'S EXPERIENCE OF SEQUENCING FINANCIAL LIBERALIZATION*

Oleh : J. Soedradjad Djiwandono
Gurubesar tetap Ilmu Ekonomi, Universitas Indonesia


INTRODUCTION

Interest on issues concerning the sequencing of financial liberalization and other aspects of liberalization have been reappearing in the wake of the Asian crises. In Indonesia, it has been publicly accepted that the crisis that struck Indonesia in July 1997 is a multi faceted crisis, affecting almost all aspects of people's lives.

The Indonesian crisis has generally been accepted to originate from a regional financial shock that struck the foreign exchange market, which reveals in some sort of a sequence, the structural weaknesses of the banking sector, the national economy, and ultimately the social and political systems. A process of deterioration seems to arise from the initial shock, the policy responses and the market and general public reactions that works through a complex interrelation with feedback effects that produces contagion.

One of the main issues that arises in the debate about the crisis is the government policy aimed at addressing the crisis and past policies that may lead to the crisis itself. Liberalization in different aspects of the national economy has often been mentioned as possible culprit causing the crisis.

Issues of sequencing liberalization are pertinent here. Of course blaming on the past liberalization in financial sector or capital account as the cause of the crisis is definitely too far-fetched. Whether the problem comes from liberalization or the lack of it or whether lack of consistency or violation of sequencing in liberalization seem in need to be addressed.

However, liberalization policies in Indonesia as well as in other economies already have some past history of both successes and failures in terms of different impacts that these policies may provide. In this presentation I would like to show liberalization policies that had been implemented in Indonesia; their respective backgrounds and implications that followed as well as some lessons that may be drawn from them.

A BRIEF OVERVIEW OF THE ISSUES

Discussions concerning financial liberalization for economic development made its entry into economic development literature in the early 1970's with he seminal works of professors Edward Shaw (Shaw, 1973) and Ronald I. McKinnon (McKinnon, 1973), which introduced the terms financial repression and financial deepening. Repressed finance is used to denote stifling environment of the financial sector that is characterized by government controlled of financial sector, both in interest rate determination as well as fund allocation.

Against the background of a prevalent repressed finance in most developing countries, a case was made for financial deepening or liberalization. By freeing interest rate determination to the market, opening up bank licensing and opening up the economy to international competition, a robust financial sector could be established to facilitate the national economy to grow and develop. A process of financial deepening would ensue whereby a more efficient financial inter mediation with variety of financial instruments would develop and a higher saving rate resulted.

The basic concept of liberalization is a process of giving the market the authority to determine who gets and grants credit and at what price (Williamson, 1998). Using this concept, John Williamson identified six dimensions of financial liberalization; the elimination of credit control, the deregulation of interest rates, free entry into the banking sector or the financial services industry, bank autonomy, private ownership of banks, and liberalization of international capital flows. It is to be noted that the term bank autonomy implies the determination of matters related to internal bank management, like appointment of managers and staff plus the payment structure, where branches are located and what kind of financial activities the bank is engaging are determined by the internal governance procedures of the bank. Other items are generally understood.

Since 1970's many developing countries in Latin America and Asia embarked on liberalizing their economies by different economic reforms aimed at increasing the role of the market and reducing the government interventions in finance, international trade and capital movements. After sometime, the evidence of these liberalization efforts were mixed, there were some limited successes and many failures (Edwards, 1984).

What happened in different crises, Latin American countries in 1980's, Mexico in 1994/95, Asia 1997, Russia and Brazil 1998/99 and Turkey and Argentina recently, seem to serve as a wake up call that make people reevaluate policies of the recent past that may have lead to the crisis. Issues of sequencing arise partly due to this type of development.

The issue of sequencing of liberalization policies relates to the objective for maximizing the benefits of liberalization and limiting certain risks that go with them. This is to say that liberalization policies are accepted as some steps that have to de taken in economic development. However, there are risks associated with liberalization. For example, in an economy that has free of imperfections the issue of what liberalization to follow the other between capital and current accounts is trivial. The issue of sequencing becomes important in a world with adjustment costs, market imperfections, and externalities. In this case, there are a number of reasons, both economic and political, why an immediate and simultaneous liberalization may be neither feasible nor desirable (Edwards, 1984,18).

The main question here is whether liberalization policies have been implemented in a proper sequence. John Williamson wrote that following the crises in Argentina and Chile, a literature developed that sought to explain the failure of the reforms in terms of incorrect sequencing of the reform programs (Edwards, 1984 and McKinnon, 1991). In the wake of the Asian crisis similar arguments have been raised, as for example the argument for a strong prudential measures and banking supervision prior to liberalization of banking, the holding of international reserves in its relation to short term foreign debts, and the like.

With respect to sequencing financial liberalization John Williamson stated that conventional wisdom came to argue for stabilizing the macroeconomics environment, implementing real sector reforms, and developing a sound system of prudential supervision before starting on domestic financial deregulation (Williamson, 1998). Furthermore, it is generally been accepted that capital account liberalization should come after current account

Be that as it may, the order of liberalization in general should include the following:

  • stabilization of macroeconomic environment,
  • real sector reforms,
  • domestic financial liberalization which should be preceded by improvement of prudential regulation and supervision, and
  • capital account liberalization.
Studies on financial liberalization and its sequencing are generally trying to find evidence whether liberalization policy does produce variety of improvements of both the real sectors as well as the financial sector itself. Donald P. Hanna in his study on the Indonesian experience with financial sector reform tried to answer issues related to
  1. the effect of financial liberalization on the financial system itself, including asset growth, maturity structure, spreads, profitability, interest rates and risk,
  2. the effects on the level of investment and savings,
  3. the impact of the macroeconomic environment on financial reform, and
  4. the sequencing of financial reform, in particular the opening of the financial system in the presence of closed current account and an open capital account (Hanna, 1994).

MACROECONOMIC CONDITION PRIOR TO LIBERALIZATION

Until the 1997 crisis the Indonesian economy was hailed for its success stories since late 1960s onward. They include, a rapid suppression of hyperinflation and transition from a controlled to a market economic system; successful exchange rate management; a rapid transition from heavy dependence on oil revenues in the 1980s; and prudent macroeconomic management. Indonesian economy during this period was part of the so-called 'Asian Miracle'. Two decades of around 7 per cent annual economic growth had produced an increase of income per capita from less than US$ 100 in late 1960s to a little over US$ 1000 in 1995. This growth had been accompanied by relatively low inflation rate and some improvements in various social indicators, like reduction of the number of people living below poverty line and an increase of life expectancy. The last one was from 48 years in the late 1960s to 63 years in the beginning of 1990s.

Since the early 1970s, the world economy has been moving toward an environment of increased uncertainty and competition. The government of Indonesia has been facing the new environment by putting in place the essential elements that would constitute the basis for sustainable economic development. This has been done by carrying out adjustment policies in all different areas with emphasis on particular aspects such as pricing policy, tax reform, export promotion, and financial sector reform.

To understand liberalization policy in Indonesia it is better for one to start from the beginning of the Soeharto government. In 1966, the New Order administration under Soeharto that succeeded Soekarno a year before launched an economic stabilization and rehabilitation program aimed at reducing inflation and ensuring sufficient supply of basic necessities. The economic chaos became a major challenge for the new government to address. The Indonesian economy was performing poorly with inflation rate that reached 635 per cent in 1966 and GDP growth rate of 2.8 per cent that went with it. In the external sector, imports continued to increase while in contrast, exports declined, which produced large current account deficits, and depletion of foreign exchange reserves.

The liberalization policy has been carried out in stages, in general in the form of policy response prompted by changes in internal or external conditions. The first stage of economic reform was introduced in response to hyperinflation and low economic growth coupled with disarray of macroeconomics management that was prevalent in the 1960s. In the late 1960s a program for economic rehabilitation and stabilization was introduced, through an adoption of balanced budget policy, opening up the economy for foreign and domestic investments, eliminating foreign exchange controls, and reducing control on bank deposit rates.

In the 1970s and early 1980s, the Indonesian economy was very dependent on oil revenue. Oil exports constituted 80 per cent of foreign exchange earning from exports and 70 per cent of revenues in the government budget. In fact, the quadrupling in 1973/74 and doubling in 1979/80 of oil prices had substantially affected the increase in the rate of economic growth that for a short period of 1979-1081 was close to 9 per cent per annum. However, the increase in the government revenues had adversely affecting the liberalization drive. Adjustment policies that in general implied a reduction of government intervention in the national economy toward more reliance on market mechanism in fact had slowed down due to the development in oil price. This is part of a Dutch decease. The increase of government revenues reduced the pressure to improve macroeconomic management. The need to liberalize the economy subsided and the reverse increased.

However, with the sudden drop of oil price and world recession in the early 1980s, the Indonesia's balance of payments was under pressure and the economic growth was drastically reduced. The drop in the oil price diminished the role of the public sector as the engine for economic growth. This development had an adverse impact as reflected in the drastic decline in foreign exchange earnings and budget revenues. These would in turn contributed to lower imports and investments that were leading to a lower economic growth. The government was forced to postpone big projects and to devalue rupiah in March 1983 by 38 percent. Another devaluation of 50 per cent was made in September 1986. Nevertheless, it is the foreign sector, the oil sector and the government sector that should be credited for the high growth of the 1970s and early 1980s.

Prior to 1983, the Indonesian financial system was dominated by the banking sector in which several states owned banks played a dominant role. These banks had the largest market share in the total volume of activities of the banking system, whereby government banks held 80 per cent of total assets of the banking sector. The branches and subsidiaries of foreign banks catered for the financing needs of their customers, primarily joint ventures between multinationals and local firms, through their offices operating in Jakarta.

Other financial institutions were in their embryonic stage during this period. The Indonesian capital market, which was reactivated in the second half of the seventies remained dormant for several years. Non bank financial institutions (NBFIs), which were established with reactivation of the capital market also changed their orientation and have become actively involved in financing companies in a way that is similar to the main activities of the banking system. Factoring companies and others were then barely in existence.

Prior to 1968 Indonesian monetary policy was subordinated to the government's financing requirements. Due to the lack of domestic resources and an overly ambitious government investment program, the government's deficit was extremely large. The deficit was largely monetized. This situation lead to a hyperinflation in the mid 1960s. The policy of the New Order Government in 1967 was to arrest the inflationary pressure by constraining itself to a balanced budget policy, thus allowing for greater independence in the conduct of monetary policy. It should be noted though that by balanced budget here the government budget is not actually balanced. In fact, the government has been allowed to incur deficit. However, the deficit could only be financed from foreign loan. Deficit financing through printing money or central bank advance is prohibited.

During the 1967-73 period, a systemic effort was made to rehabilitate the Indonesian banking system in accordance with a more market-oriented outlook of the New Order administration. The main aim of the rehabilitation was to halt the hyperinflation by stringent fiscal controls and to create a banking system that could play an active role in servicing development activities. During this period a new Central Bank Act and a new Banking Act were introduced; a modified balanced budget was adopted whereby the reliance of money creation or domestic public debt was prohibited, and opening up capital account was adopted.

From 1974 to 1983, the Government conducted a direct monetary policy through the use of various monetary instruments such as ceilings on bank credits, the determination of the interest rates of state banks and the provision of liquidity credits (subsidized interest rates) to financing of priority sectors.

Ceilings on bank credits played the most important role in controlling liquidity expansion in line with the absorptive capacity of the economy. The ceilings on bank credits were allocated to the banking system on the basis of its performance in the preceding year. In the later stage of the implementation of this policy, the allocation of bank credits also put some emphasis on development priorities in the form of programmed credits, which were mostly implemented by the state-owned banks. This policy was complemented by liquidity credits, a form of subsidized credits financed by central bank, which were channeled through the banking system.

Another related policy was the introduction of the interest rate ceiling on deposits, which enabled banks to lend at low interest rates and encouraged investment activities. This policy, however, led to negative real interest rates, which inhibited the mobilization of funds from the public at large.

EARLY STAGE OF LIBERALIZATION

The slackening world economic growth and drastic drop of oil prices in the early 1980s had adversely affected the Indonesian economy. The Indonesian government confronted the slackening economy with a new determination to launch structural adjustment programs in different key areas of the national economy. Adjustment policies, known as deregulation and debureaucratization programs that encompassed both macroeconomic management; sectors liberalization and micro programs were embarked.

On the macro side, the adjustments were aimed at achieving certainty and maintaining macroeconomic stability. To this end, imposing the necessary discipline for sound macroeconomic foundation was crucial. This comprised, firstly, a fiscal policy focusing with increasing government revenues and reducing expenditures by taking steps to simplify the tax system, reduce subsidies, and ensure efficient expenditure in order to sustain a dynamic balanced budget. Secondly, it required a prudent and consistent monetary policy including measures to safeguard price stability both in terms of domestic prices and the exchange rate. Policies were also adopted to bring about a more sustainable current account of the balance of payments, manage external debt and to develop a borrowing strategy, as well as to maintain sufficient foreign exchange reserves. Fiscal and monetary policies were carried out with the objective of providing an appropriate framework for a market-oriented economy.

The above reform was accompanied by equally important measures on the micro side. Here measures were aimed at increasing the effectiveness and efficiency of various government units. Also, the Government had to support and promote a climate conducive to business.

Both macro and micro adjustment measures were crucial in facing an increase in competition and uncertainty; nevertheless they needed to be complemented by sectors adjustments. Sector economic policies can be differentiated into the real sector, such as production (manufacturing, agriculture, etc.), the distribution sector (trade and services) and the financial and banking sector. The goal of sector measures was to increase the effectiveness and efficiency, and hence the competitiveness, of all sectors of the economy, including the financial sector. Its design was to eliminate the over-regulation of our economy by reducing government controls and by relying more on market mechanisms. Nonetheless, government intervention was still used if, and where, conditions necessitated.

Indonesia, like other developing countries, faces a gap between its high, but limited savings and its investment needs. Financial sector development is needed to improve intermediation between depositors and investors. Therefore, the government focussed its efforts to adjust the financial sector for enhancing their activities to support economic development. Reforms in the financial sector were exercised as an integral part of the overall adjustment policies.

In strengthening economic fundamentals, adjustment polices were aimed at addressing the following objectives:

  1. To move toward a predominantly market-based financial system;
  2. To provide effective protection to the general public so that they can benefit from the services offered by the financial system; and
  3. To build an efficient and strong financial system that can support stable and healthy economic growth.
In the banking sector, liberalization measures started in June 1983, with a government announcement to introduce its first serious deregulation effort by allowing interest rates to be determined by market mechanisms. With the new policy banks could determine their own deposit and lending rates.

Formerly, Bank Indonesia determined the interest rates of state banks for both deposits and loans. Since state banks held the largest market share (80 per cent), all interest rates were virtually determined by Bank Indonesia. These regulated rates were often too low to encourage domestic savings. After June 1983, the determination of interest rates was left to each bank's discretion, thereby becoming more attractive to depositors. Concurrently, Bank Indonesia lifted credit ceilings and introduced monetary instruments, namely Bank Indonesia Certificates (SBI) in 1984 and Money Market Securities (SBPU) in 1985, which were used as indirect monetary controls.

FINANCIAL LIBERALIZATION IN 1988 AND BEYOND

The process of liberalization in the financial sector was continued. In October 1988, the Government released its most important deregulation package, which fundamentally changed the face of banking in Indonesia. Pakto, as the package came to be known, removed the restrictions on new private banks, which had been in effect since 1971.

The financial liberalization in October 1988 was far reaching in lowering barriers to entry in finance. The steps that were taken by the government included the followings:

  • Bank licenses were made available to new banks that could meet new minimum capital requirements
  • The process for obtaining a foreign-exchange license was simplified
  • Freer branching by domestic banks was allowed so long as standard of prudential soundness were met
  • Foreign joint-venture banks were authorized, with an extended branching network
  • Limitations on the activities of banks and non-banks were lessened
  • State enterprises were allowed to hold up to 50 per cent of their assets in private banks
  • The right to issue CDs was extended to all banks and non-banks financial institutions
  • The burden of monetary control was lowered by a reduction in reserve requirements from 15 per cent to 2 per cent of deposits.
Measures to promote competition were combined with improvements in prudential supervision of banks. In this respect, Bank Indonesia imposed legal lending limits, which restricted banks' aggregate amount of loans and advances to 20 percent of bank capital for any customer, and to 50 percent of bank capital for any one group of companies with common ownership. These limits were designed not only to prevent banks from being over exposed to a limited client base but also to drive large business conglomerates to seek market based financing from a range of financial institutions.

Bank Indonesia also took steps to liberalize the capital market with the aim of creating an environment conducive to investors as well as maintaining investor confidence. In December 1988, the government introduced measures to energize the capital market that had seemingly slept through the previous decade. The previous regulations limiting daily price swings to 4 percent of the price of a stock, was abolished and foreigners were allowed to buy some shares. Foreign security houses were also given the green light to form joint ventures with local partners. The sudden emergence of competition from the equity market in 1989 had a profound effect on how banks marketed themselves to customers.

Refinement of prudential regulations was introduced in March 1989. For example, the regulation on absolute limit on external borrowing was replaced by restriction on the net open position of banks in foreign exchange, i.e. 25 per cent of equity. The requirement of prior Bank Indonesia approval of off-shore lending was eliminated, which in effect allowed banks to borrow off-shore freely so long as they lent domestically in foreign exchange or otherwise covered their position. This also implied further liberalization in the capital account.

These measures encouraged more advanced banking activities, as reflected in a number of banking indicators, such as the number of banks as well as the value of funds mobilized and loans extended. As this growth was taking place, the Indonesian authorities remained concerned about the importance of maintaining macroeconomic stability, since Indonesia's experience had showed that macro management was a necessary condition to support economic development.

In January 1990, the credit system was further improved by streamlining liquidity credits to three priority areas: food procurement, cooperative, and investment. The policy was aimed at lowering inflationary pressures and excess liquidity (which might have had unfavorable affects on mobilizing savings) and at improving the credit structure through removing distortions in market mechanisms by allowing more market oriented interest rates. The measures also resulted an increase in the efficiency of the allocation of funds, promoted the role of banks in managing and carrying out the national credit system, and enhance Bank Indonesia's role in monetary control.

Steps to increase prudential measures were considered to be equally important and continuing with its efforts to create a sound banking system, Bank Indonesia introduced a new set of measures at end of February 1991. These measures included the introduction of capital adequacy requirements for banks, and encouraged bank to improve their management strategy and operational systems.

The New Banking Act, which provided a legal foundation for responsible banking management that included the rights and obligations of related parties was also, introduced at the end of March 1992. To enforce the new act, a series of government regulations concerning the operation of commercial banks, rural credit banks, and profit sharing banks were introduced which further strengthened efforts to promote sound banking, and provided guidelines for their operation. To encourage banks to abide by prudential principles, Bank Indonesia updated the improved Net Open Position (NOP) regulations in September 1994, which eased the NOP limit for transactions up to 25 percent of bank capital, for both balance sheet and off-balance sheet transactions. Banks were therefore given more leeway to make necessary adjustments to their open positions.

In May 1993 some improvements (often dubbed as modifications) of bank regulation were undertaken. They were expected to stimulate further lending activities in the short-run. The modification of the prudential standards included: phased deadlines for compliance with the legal lending limit and a modified formula for the capital adequacy requirement (CAR). Through these provisions, the previous restriction of group lending to 50 per cent of capital was reduced to 20 per cent, with implementation to be accomplished in phases over roughly the four years to March 31, 1997; within that period, group lending would have to be reduced to 35 per cent of capital by December 31, 1995. The existing 20 per cent limit on individual lending remained unchanged; however, the legal lending limit for parties affiliated with the bank was reduced to 10 per cent of bank capital.

This represented a significant change in our prudential regulations and so we felt it would require a somewhat lengthy time period for compliance. Our developing capital market will be incapable for some time of providing the necessary volume of alternative funding for groups and insiders currently borrowing in excess of these new lending limits. We feel confident, however, that our flourishing capital market will provide an alternative source of funding to enable group borrowers not just to maintain current funding volumes, but to expand their business activities without continuing to rely so heavily on the banks.

In 1994 and 1995, in line with efforts to strengthen the application of prudent principles, Bank Indonesia encouraged banks to adopt "Self Regulatory Principles". Banks were asked to have regulations, systems, standard procedures and policies to ensure that their operations were in accord with sound operational and prudential principles. In this regard, Bank Indonesia issued some guidance concerning "Bank Annual Business Plan", "Annual and Published Financial Statements", "Guidelines for the Formulation of Bank Credit Policy", "Standard Practices for Bank Internal Audit Function", "Guidance for the Uses of Information System technology", and "Guidance for Derivative Activities".

SOME IMPACTS OF LIBERALIZATION

All of those adjustment policies began to pay dividends as shown by many economic indicators. For more than two decades, the Indonesian economy had registered relatively high growth levels that averaged 7 per cent per annum. The strong economic growth has enabled income to rise considerably. The favorable figures were substantiated by other factors.

Firstly, the successful transformation of our economy from one reliant upon the oil and gas industry to one with a diversified manufacturing and production base. In 1985, nearly 67 per cent of Indonesia's exports consisted of oil and gas products. Today, Indonesia is much less economically and fiscally dependent on the oil and gas sector as the oil sector makes up less than 30 per cent of our exports. Oil exports have decreased from 37 per cent of total exports in 1991 to 22 per cent of total exports in 1996.

Secondly, the structural transformation that began in earnest in the mid-1980s in response to weakening world oil prices and a concurrent drop in the value of US dollar. The benefits of diversification from the oil sector go beyond the country's external accounts. Our fiscal dependence on oil-related revenues has also dropped significantly as manufacturing and agriculture have grown to prominence. In 1991, revenues from oil and gas were 35.4 per cent of all domestic revenues. 1996 reduced this number reduced to 18.1 per cent of total revenues once again, largely from increased manufacturing and agricultural growth. To put this in perspective, our fiscal dependence on oil-related revenues, similar to that of exports, was also much higher in 1985 at approximately 58 per cent..

Thirdly, the main sector that has fueled the diversification process is manufacturing. Manufacturing exports accounted for 40 per cent of total exports in 1995 versus 58 per cent of total exports in 1991. This reflects, in part, the higher value-added nature of manufactured goods and increased public and private emphasis on this sector. In this regard, I can state emphatically that the continued growth of the non-oil exports sector, particularly that of manufacturing goods, will be an important part of Indonesia's future success.

In line with the positive results of adjustment measures, the outcome of the specific financial reformation were impressive. Our banking industry has recorded a dynamic advancement, both in terms of the amount of banks or offices and in terms of mobilization of financial sources. As of the end of 1996, we have a total of 239 banks with more than 6,000 bank offices, compared to 124 banks with about 1,900 bank offices in October 1988. In the same period, funds mobilized by banks reached Rp281 trillion with total bank loans of Rp292 trillion as compared to Rp38 trillion and Rp49 trillion respectively previously.

Along with the progress in the banking sector, the domestic money market has also expanded rapidly, with especially strong performance in the foreign exchange market. In 1993, for example, the daily average volume of clearing and interbank transactions in the domestic money market was Rp5 trillion. In mid 1997, this volume reached around Rp25 trillion. Similarly, the volume of foreign exchange transaction has soared from US$3.0 billion per day to more than US$10 billion.

Similar gains have taken place in the capital market. Since early 1989, this market has grown in almost all respects: the number of companies listed, volume of trading, funds mobilized, market capitalization and number of participating securities companies Foreign investors have played a part in the development of the capital market. All of these developments have linked the domestic market to the international market. As of June 1997, there were 286 companies listed on the Jakarta Stock Exchange (JSX) with a market capitalization of Rp260 trillion.

Another important thing that financial reforms have fostered is a more effective market mechanism within the banking system, thus enhancing its function as a financial intermediary. Efforts toward deregulating our banking industry, for example, have led to increased competition among banks, prompting in turn greater efficiency. Banks are now more independent in terms of being able to set their own business strategies. They have become more market-oriented; as reflected in the price banks have established for deposits and loans as well as in the variety of new financial products they have introduced for their consumers. Bank financing to the business community, for instance, has now gone beyond traditional bank loans to other forms of financing, such as the introduction of commercial paper. We believe that greater dependence on market forces has allowed, and will allow, our financial markets to operate more effectively and efficiently in terms of mobilizing and allocating the nation's financial resources.

The rapid expansion of the Indonesian financial sector has played a significant role in its development. Studies in specific and systematic impacts of financial liberalization in Indonesia had been done by many (Hanna, 1994, Goeltom, 1995, Binhadi, 1995, Cole&Slade, 1996, Nasution, 1998).

However, the development of our financial market also created some challenges since it has now been integrated into the world financial market. As capital tends to seek higher returns, capital flows will move easily from one country to another, bringing more instability to our financial markets and complicating our monetary management.

POLICY RESPONSE FACING FINANCIAL CRISIS

As the Indonesian economy becomes more integrated into the global economy, it will also become more sensitive to disruptions on an international scale. Any event, economic or otherwise, in Indonesia or other countries will impact the financial sector and hence also economic stability. It is important to take into account the increased risk of the contagion effect, namely that disruption in one economy can quickly spread to other countries, despite strong economic fundamentals.

In today's globalize world, the problems of any single country can no longer exist in isolation. Clear evidence of this is visible in the financial market crises suffered by several countries suffering from Asian crisis, Russia and Brazil, with the latest victims being Turkey and Argentina. As in the case of Mexico in 1994, developments following the fall of the Thai baht in July 1997 demonstrated that a crisis in one country could generate spillover effects in other countries.

Confronted with the financial panic in July 1997 a series of adjustment steps were taken by the government of Indonesia. The initial policy response to the currency problem was prompt, starting with an immediate step to widen the central bank intervention bands in the foreign exchange market at the same day the Philippine peso was floated, or more than a week after the Thai bath's.

However, a completely different reaction came from the market. On previous occasions, every time Bank Indonesia widens the intervention bands - 6 times since 1994 - the rupiah had appreciated. In fact, previously the dollar spot exchange rate closely followed the buying rate of Bank Indonesia. But, this time, the rupiah depreciated after the bands were widen. The spot rate of the dollar not only broken through the mid-rate, but it also broke through the selling rate or the upper band. The latter prompted Bank Indonesia to intervene in the market. It could now be said that what happened in July 1997 was definitely different from previous periods of pressure in the currency market; it was, actually, the contagion effects in progress1.

Faced with persistent pressure on the rupiah, the government intervened in the foreign exchange market, first by selling dollar forward, and later, in the spot market. By August 14, these market developments had reached a stage that led to Bank Indonesia's decision to remove the intervention band. Since that date, Indonesia has managed its currency under a free-floating exchange system. Previously, we found in the past that our managed float was very effective for many years. Indeed, it was among the most open systems in the region. But after other Southeast Asian economies began changing to free floats, we suddenly looked primitive and vulnerable. Keeping a managed float with an intervention band would have ultimately drained the Indonesia's reserves.

Along with the free float of the rupiah, the government adopted tight monetary and fiscal policy as a means of reducing fluctuations in the exchange rate. On the monetary side, Bank Indonesia, for instance, halted new offerings of short-term money market securities (SBPUs), and raised the rates of Bank Indonesia Certificates (SBI). This policy was urgently needed to restrain the rupiah depreciation and its implications. On the fiscal side, the government, among others, made several policy adjustments consisting of the postponement or rescheduling a number of government budget programs and projects. All these measures were crucial to bring domestic liquidity down to a more appropriate level.

On August 29, Bank Indonesia also limited U.S. dollar forward transactions, including swaps and options, by domestic banks to non-resident to US$ 5 million for each bank. However, exempted from this ruling were funds transactions for portfolio investments and import-export needs. This move was intended to reduce currency speculation by non-residents.

I should be noted that by adopting this measure, Indonesia did not intent to single out non-residents as the sole source of our current difficulties. The government was fully aware that heavy pressure on the rupiah was caused by not just overseas fund managers, but also by domestic corporations that had short dollar positions as a result of over-confidence in the rupiah before. As a result of their short position, when the rupiah came under attack, they panicked and scrambled to cover their positions by any and all means.

Crisis in several countries has demonstrated that the condition of the financial sector, particularly banking has played a vital role. A healthy banking sector enables the monetary authority to implement its instruments more effectively. For this reason, the government of Indonesia we had been engaged in a concerted drive to strengthen the underpinnings of the banking system by encouraging merger or liquidation of insolvent banks. However, the results of these policies had not been encouraging so far.

Realizing the fact that the problem had spread to the banking sector, in early September 1997 the government launched a broad economic policy initiative, which encompassed not just monetary and fiscal measures, but also deregulation steps in the real sector. This was a precursor of an IMF-supported program, which came later, at the end of October 1997.

FUND SUPPORTED ADJUSTMENT PROGRAM

The IMF-supported program initiated with the first Letter of Intent with a Memorandum on Economic and Financial Policies (MEFP), which was submitted to the Fund on October 31, 1997. The program comprised of a package of policies for economic reform in the real sector and financial restructuring that was supported with prudent monetary and fiscal policy. The monetary and fiscal measures comprised of standard programs of macroeconomic management to cope with exchange rates and other monetary disturbances together with fiscal ramifications.

The core of the program comprised of a comprehensive policy package to deal with insolvent and weak banks and the financial infrastructure, including the strengthening of banking supervision, and to overcome structural rigidities in the real sector of the economy. Thus, the framework was put in place for a comprehensive policy to restore confidence and arrest the depreciation of rupiah.

The program is comprised of the followings:

  • A broad range of real sector structural reform, which is comprised of four areas: dismantling monopolies, deregulation measures, trade and investment liberalization, and privatization. This also includes improvement of governance and transparency
  • Bank restructuring with four areas of concentration, namely:
    1. the closure and liquidation of the weakest banks with government guarantees to depositors and creditors;
    2. the rehabilitation of the weaker of the remaining banks through the disposal of bad loans and bad assets, mergers, and the infusion of government capital;
    3. the strengthening of the relatively better banks again through the disposal of bad loans and through recapitalization by the government as well as by private foreign and domestic investors with no limits on a foreign ownership. These banks will form the core of the new system; and
    4. the negotiated resolution of the debt of domestic corporations to domestic banks. This will be done in conjunction with case by case workouts to restructure the external debt of this corporation. The new bankruptcy law should ensure that both parties come to the negotiating table.
  • Fiscal policy which includes a substantially increased subsidy because of the continued depreciation of the rupiah and the cancellation of further price increases for basic foodstuffs, petroleum products and electricity, increased expenditure for health and education, and the expansion of employment-creating investment projects at the community level.
  • Maintaining tight monetary policy with no growth in base money and NDA to strengthen the rupiah and to bring inflation down quickly.
Initially, the implementation of the program received a positive response from the market, the external market in particular. The closing of 16 insolvent banks and joint intervention in the currency market by Bank Indonesia, together with the Monetary Authority of Singapore and the Bank of Japan, were welcomed by the (external) market and resulted in strengthening the rupiah from 3900 rupiah to 3200 rupiah to the dollar.

However, the domestic reaction on the closing of banks was the reverse of what was expected. It was ironic that a step, which was designed to bring back confidence to the banking sector, had resulted in the collapse of confidence instead. In fact, the bank closure had plunged the banking sector into chaos. The banking sector has suffered from a 'flight to safety and to quality' since then.

Furthermore, many banks lost their deposit base inter bank money market suffered from compartmentalization, and since January 1998, letters of credit issued by Indonesian banks were not accepted abroad. The problems of confidence in the national economy basically involved three areas: the rupiah exchange rate which was weakening dramatically against the dollar, the banking sector which was losing its deposit base as well as creditors, and the business sector that was unable to repay foreign debts.

After some flip-flop implementation of the IMF-supported program with a record four Letters of Intent in seven months, coupled with social unrest spearheaded by continuous students' demonstrations, the confidence problem shifted from not just an economic problem but to a problem of national leadership as well. When Suharto was still in power the overriding question was his sincerity in implementing the difficult reform program. Actually, the foreign market lauded the decision of closing 16 insolvent banks in November 1997. However, when some political intervention by the government was suspected on the execution of bank closures, the foreign market started to react negatively. Domestically, the closing of banks was badly received. There was public perception that a second wave of bank closure was eminent and further loss of confidence in the banking sector followed. This had basically transformed the banking sector from a state of distress into a crisis when market confidence was almost completely lost.

The negative reaction to the implementation of the reform program was more pronounced when a reversal was announced of some decisions to postpone big government projects. At about the same time there was a reappearance of monopoly practices and some other inconsistencies in the implementation of the program for restructuring the real sector. This was how market confidence evaporated in the government's commitment to the program for economic restructuring. As a result, the rupiah downward slide was not just difficult to stop, but the economic crisis was rapidly shifting into a total crisis in a downward spiraling process. President Suharto had to pay dearly for not addressing the problem head-on by resigning in humiliation on May 21, 1998.

MACROECONOMIC ADJUSTMENTS

As stated in the IMF supported program for economic reform, essentially the program is comprised of economic restructuring of the real sectors, and financial restructuring, complemented by prudent fiscal and monetary policy. This is then extended to include steps to address problems related to subsidies for the social safety- nets and private sector debt overhang. The real sector reforms, including privatization, are aimed at reducing inefficiencies in the economy, uprooting monopolistic and oligopolistic practices, increasing transparency and abolishing corruption.

Many studies have clearly shown the close link between the soundness of the banking system, which is the subject of microeconomic analyses, and monetary policy, which belongs to macroeconomics. Neither effective monetary policy for neither stability, nor well managed macroeconomic policy for achieving growth and stability, can be sustainable without the existence of a sound banking system. In this respect, Manuel Guitian argued that banking soundness should be treated as an objective for monetary policy, together with price - and exchange rate - stability (Guitian, 1997).

In the meantime it has been documented that since 1980 up until just before the Asian crisis broke out in July 1997, over 130 countries had experienced banking problems, either significant banking problems or banking distress and banking crises. It also appears to be a fact that more problems had been observed in the latter part of this period, and that both the nature and the intensity of the problems as well as their ramifications had been increasingly severe (Lindgren, 1996). This seems to indicate that, despite increasing awareness about the close link between the micro and macro aspects of monetary policy, over time more countries have been experiencing banking problems and the problems are becoming more serious while their impacts are worsening.

The above development has contributed to the many studies conducted and resolutions and policy proposals made to cope with the problems2. The latter came notably from the G-7 communiqué after the Lyon Summit in June 1996 and the Interim Committee's Declaration, Partnership for Sustainable Growth, in September 1996.

It may be important to reiterate that; "an appropriate macroeconomic policy stance is unlikely to be sufficient to maintain balance in the economy unless it is supported by sound underlying microeconomic conditions". This is true on the fiscal front as well as in the area of monetary policy, be it in exchange rate management, external debt-management, or in the focus of our discussion in this symposium, the area of monetary policy and banking soundness3. These propositions have been recognized and widely accepted. They have developed from past experiences in many Latin American countries in the early eighties, savings and loans associations' problems in the United States, exchange rates problems in Europe with the Exchange Rate Mechanisms (ERM) experiment, the Mexican crisis, and several others4.

It is a bit of an irony that Managing Director Camdessus, in his closing speech of the International Monetary Fund (IMF) seminar on central banking at the beginning of 1997 said that "Last year I said that I suspected the next international economic crisis would begin with a banking crisis or almost certainly be compounded by one. Let us hope that all of our efforts to increase the awareness of financial sector problems and to seek solutions to them will lead to serious reforms - both nationally and internationally - that promotes sound banking and market discipline. Through these efforts, including events such as this seminar, we can substantially reduce the possibility of my suspicions becoming reality."5 It turned out that the Asian crisis was already in the making then.

BANKING RESTRUCTURING

It has been conjectured that banking soundness is vital for a sustainable macro-economic management of a national economy. Despite the continuous competition from other financial intermediaries as a result of the globalization process, the banking sector still plays a dominant role in a national economy, particularly in developing countries. The condition of the banking sector generally reflects the status of the financial sector as a whole. Thus there is the over-riding concern over bank soundness.

According to the IMF Executive Board, efforts to strengthen the banking system should be guided by the following principles6:

  • the soundness of a bank is first and foremost the responsibility of its owners and managers; yet the soundness of a banking system is a public policy concern;
  • bank soundness is crucially linked to sound macroeconomic policies;
  • a framework for sound banking must include structures to support internal governance and market discipline, as well as official regulation and supervision; and
  • international cooperation and coordination can play an important role, not only in strengthening the global financial system, but also in improving the soundness of the national banking system.
Let me summarize how banking restructuring was conducted in Indonesia with a view to the principles mentioned before. Before the current banking crisis, the most recent experience of dealing with problematic banks was the closure of Bank Summa, a sizable bank, at the end of 1992. A significant number of banks, including most state banks, were faced with serious non-performing loans, partly due to the drastic monetary policy implemented during 1991-1992 to halt the overheating of the economy. The IMF classified the condition of Indonesian banks then as experiencing significant problems. The closure of Bank Summa was a distressing experience since it took a long time to be resolved. However, in the course of time, conditions improved as shown by the national average of non-performing loans, which declined from 25 per cent of total lending in 1993 to 12 per cent in 19957.

The banking crisis was preceded by a short period of distress when, due to a process of erosion of confidence, banks lost their deposit bases. In addition, the inter-bank money market functioned poorly, in that it suffered from compartmentalization. Weak banks had to rely on Bank Indonesia to keep afloat. Confidence was completely lost when "flight to quality" was rampant and a substantial number of banks were confronted with bank-runs within a short period. Strangely, in the recent Indonesian experience, these phenomena happened following the closure of the 16 banks in early November 1997, which was originally designed to boost confidence in the banking system. Individually, a bank confronted with a problem of mismatched liquidity could easily become insolvent. For the banking sector, the problem changed from distress to crisis.

When the currency crisis spread to inflict the national economy, the government's efforts to address the banking problems were combined with other policies and treated as part and parcel of the adjustment policies for stability and sustaining growth. But, this treatment was more explicit in the IMF supported programs, from the first letter of intent in November 1997 to the most recent one in August 2001.

In 1997 the Indonesian government asked for a three-year stand-by loan from the IMF, which was processed through an emergency procedure. The amount of the stand-by loan was SDR 7.3 billion, and together with those provided by the World Bank and the Asian Development Bank, the total loans amounted to US$18 billion. This amount, plus US$5 billion of Indonesia's own reserves set aside for balance of payments support, made a total of US$ 23 billion available to be drawn. Together with bilateral facilities in the second line of defense the total amount of the rescue package amounted to US$ 43 billion.

Basically, the IMF supported program was comprised of a comprehensive policy package to deal with insolvent and weak banks, and to overcome structural rigidities in the economy, supported by prudent fiscal and monetary policy. The financial restructuring program, which had been put together with technical assistance from the IMF, the World Bank, and the ADB to restore public confidence in the financial system, was comprised of five parts, namely:

  • the closure of 16 insolvent banks, which was executed on November 1, 1997.
  • the establishment of proper procedures and policies to deal promptly with weak but viable financial institutions, so that they can be placed quickly on the road to recovery; some banks were to be put under intensive supervision by BI.
  • the resolution of specific problems of state and regional development banks.
  • the strengthening of the institutional, legal and regulatory frameworks for banking operations to ensure the emergence of a sound and efficient financial system; this program includes the modification of such laws as the central bank law, the law on bank liquidation, and the bankruptcy law.
  • the establishment of Indonesia Bank Restructuring Agency (IBRA), after the second Letter of Intent.
The program of banking restructuring was part and parcel of a comprehensive program that comprises both the real and financial sectors, supported by prudent fiscal and monetary policy.

If we look at what was put into the program, one could argue that the right steps were taken to address the Indonesian crisis. But, why is Indonesia's IMF supported program showing negative results thus far? In comparison with the implementation of other IMF supported programs, the Indonesian case is definitely the worst, particularly when one compares the rate of currency depreciation, growth prospects, inflation, and the development of other variables in the respective countries.

The IMF supported program that Indonesia is implementing includes a comprehensive restructuring of the banking system. With the help of the ADB, the World Bank and the IMF, IBRA is working to address the problems of the weak banks through a combination of mergers, recapitalization and ceasing the operations of insolvent banks. The bad loans of the banks are to be transferred to an Asset Management Unit (AMU) to be established within IBRA.

To strengthen relatively sound banks, schemes will be announced soon which will allow banks that achieve a special increase in capital can sell their bad loans to the AMU so that they can improve their CAR. In addition, a provision will be made for the creation of tier- two capital in the form of subordinated loans to banks whose capital has been increased by their owners.

Discussions are under way with foreign banks regarding investment in the banking sector. To facilitate the process all restrictions on foreign ownership of banks will be lifted as part of the prospective amendments to the banking law. As an interim measure, foreign bankers will be retained to strengthen the management of banks under IBRA's control.

All banks are to achieve minimum capital adequacy ratios of 4 percent of risk-weighted assets by the end of 1998, rising to 8 percent by the end of 1999 and 10 percent by the end of 2000.

These are, of course, necessary steps to get the banking sector back to a normal footing, i.e. being solvent. However, for the banking system to be sound most banks should be solvent and are likely to remain so. The IMF stipulates that the likelihood of remaining solvent will depend, inter alia, on banks' being profitable, well managed, and sufficiently well capitalized to withstand adverse events8. But, aside from the fact that the banking sector has to be sound, all infrastructures - namely regulations, prudential measures, disclosures, accounting practices and the legal base - to support the industry have to be working well. Manuel Guitian, mentions the three-pillar paradigm for banking soundness, namely official oversight (the prudential standard), internal governance (risk management in each individual bank), and market discipline (sound banking practices). But, this paradigm still has to be complemented with adherence to several principles for strengthening the banking system: responsible owners and managers of banks and professional authorities, prudent macro management and, in a globalize financial system, good international cooperation.

The problems that the Indonesian banking system is presently facing seem to be very complicated indeed. The steps, which need to be taken, are often problematic. In a way, measures which had been taken all these years to put the prudential regulations in place were wiped out by the crisis. At the same time, an opportunity arises to put all the necessary pillars for sound banking system in place. A comprehensive program towards that seems to be in place. What has to follow is the discipline to implement the program.

But the linchpin of all the above issues is still the stability of the Rupiah at a reasonable rate. The Government in addressing these pressing problems has made some progress, but the market has still not made any positive move. In my view, this actually means that somehow 'a turn around' still has to come before the market players - the traders, investors, and creditors - are willing to act positively to the development of the Indonesian economy.

The positive response from the market has to be preceded by a positive perception, which has not come out yet. A positive perception could come when market confidence is back. John Maynard Keynes showed us 62 years ago about the importance of confidence in an investment decision, aside from the marginal efficiency of capital. However, it is difficult to define what confidence really means. I could only say that, indeed, market confidence is crucial. Confidence is very difficult to describe. We will only know how crucial it is when we do not have it. When confidence is present the market is not very demanding. However when it is lost, everything we do is not good enough, and the market is extreme.

SOME LESSONS

The Asian crisis, which has been lingering on shows that globalization, has brought both ample opportunities and risks. Indonesia, together with Thailand and Korea and other countries has benefited substantially from the openness of the respective economies as well as the huge inflows of capital since the beginning of the nineties. However, a sudden change of market sentiment from optimist to pessimist, in a less than sound banking sector and unsustainable corporate debts, has enabled a financial shock to trigger a banking crisis, and then a total all-encompassing crisis, including economics, social and political issues, in a short time.

From both the processes of how the problems arose and the policies that the authorities adopted, lessons could certainly be learned for monetary and financial management, at least on some mistakes that could be avoided. The following points are lessons, which we could learn from the crisis and steps in monetary and banking policy, which could be implemented:

  1. Regarding financial development prior to the crisis, some lessons from financial liberalization, which for Indonesia was done in the eighties and nineties, are in order. Banking liberalization has to be done in coordination with the improvement of the financial infrastructure, including proper regulation and strict prudential measures, adequate disclosure, governance, legal protection, and market discipline. Studies have also shown the possible sequencing of financial liberalization, even though different condition may require a different sequence9.
  2. On the liberalization of capital flows, Indonesia's experience seems to show that the monetary authorities had followed a reversed sequence. Rupiah has been fully convertible since the seventies and there are practically no measures to control capital flows. I think some caution articulated by Professor Bhagwati in the May/June 1998 issue of Foreign Affairs deserved to be considered10.
  3. Lessons from the crisis in the eighties are still valid here, namely that the sooner the better and the problems are always worse than expected11. This seems to be true for both monetary policy and banking reform. A study of Indonesia's banking problems and the steps to resolve them, undertaken by the Monetary and Exchange Affairs Department of the IMF in 1996, indicated that in terms of both the number of problem banks and the cost for their restructuring, the current figures were much larger than previously. Basically, the sooner the problems are identified, recognized and properly treated, the better the chances for being successful, and the smaller the cost involved12.
  4. On banking soundness as a requisite for sustainable monetary policy, I would argue that the Indonesian experience supports it. We may even suggest that the linchpin of the crisis is the weak banking system, which has constrained the monetary authority in conducting monetary policy and banking supervision as well as facilitating payments system. I think the inclusion of banking soundness as an explicit objective of monetary policy is in order.
  5. In an effort to create a sound banking system by implementing a program that combines banking restructuring and monetary management, we have to be very cautious about the fact that we are working with variables which are different in terms of their time frame. Monetary policy in general is a short run issue, dealing with short run variables, even though it has long term implications. Tight or loose monetary policy is a short run issue. It deals with macroeconomics variables. Banking restructuring is, however, a long-term problem. It deals with problems of efficiency, management, supervision, regulation, law enforcement, banking ethics, etc., which are microeconomics issues. These have to be considered carefully in designing and implementing banking reform together with monetary policy. In addition, as Manuel Guitian argues, there are interaction and feedback effects between bank soundness and macroeconomic policy choices. Conflicts between the aims of price stability and bank soundness entail an intertemporal trade-off13.
  6. The Indonesian experience also teaches us that when public expectation is fragile, the closure of insolvent banks even though a must for creating a sound banking system, could have an adverse result. A step, which was originally intended to regain public confidence, resulted in a further loss of confidence. It may not be realistic, but the liquidation of banks should be done when the economy is not fragile. And, in general, the sooner the better. The sooner the authority identifies the problems, the sooner the authority accepts the reality about the problems, and the sooner a well prepared restructuring steps are implemented, the better. Why? Because it will be less costly, and the chance for success is better.
  7. I observe that, even though there has been an increasing awareness of the close link between banking soundness and macroeconomic policy, partly due to the socialization by the IMF and others, it has not adequately prepared monetary authorities and market players in developing countries to cope with the crisis. This lack of preparation has created devastating impacts, especially in Thailand, Korea and Indonesia.
  8. In the Indonesia's case, the monetary authority had been endeavoring to take steps to strengthen the banking system before the crisis, including reorganizing banking supervision, developing 'self regulating banking systems', raising reserve requirements, curbing credit expansion for property, etc. to prepare for the uncertainties. It seemed the monetary authority had been taking steps in the right direction to cope with possible external shocks. But, the crisis was so devastating that what the monetary authority did, even if it was right, was simply too little and too late.

SOME NOTES

  • Indonesia's experience in liberalization cannot be characterized as typical or following a particular pattern of sequencing. In fact, as noted by David C. Cole and Betty F. Slade, the process of financial development has not been linear or based upon some 'grand design'. It has instead progressed rapidly in some sectors during some periods and then stagnated or even retrogressed in those same or other sectors in other periods (Cole and Slade, 1996, 353).
  • The sequencing of liberalization in Indonesia in some sense seems to put it on its head. It started with fiscal stabilization followed by removal of foreign capital controls, and after sometime by removal of credit and interest rate controls, removal of barriers to entry in banking, and again after sometime by reduction of trade barriers and market distortions. Both the sequences of capital and current accounts liberalization as well as barrier to entry in banking and banking supervision were not typical.
  • For many years prior to the financial crisis of 1997, the combination of controlled fiscal deficits, open account and low inflation has put the issue of central banking independence trivial.
  • Indonesia's experience with the 1997 crisis and its aftermath has raised some questions on the merits and demerits of past policies. John Williamson, for example, stated that for a long time it was common to argue that investors in Indonesia with concern about the stability of the financial system were hedged against such risks even before the start of domestic financial liberalization in 1983 because of the open capital account. It has also been argued that the open capital account provided a helpful discipline on macroeconomic policy. The crisis of 1997 revealed that the corporate sector had taken advantage of the open capital account to incur unhedged foreign-currency debt (Williamson, 1998).

REFERENCE

Binhadi, 1995. Financial Deregulation Banking Development and Monetary Policy: The Indonesian Experience, Jakarta : Institut Bankir Indonesia.
Cole, David C. and Betty F.Slade, 1996. Building a Modern Financial System: The Indonesian Experience, Cambridge: Cambridge University Press.
Dekle, Robert and Mahmood Pradhan, Financial Liberalization and Money Demand In ASEAN Countries: Implications for Monetary Policy, IMF Working Paper, No. WP/97/36, Washington DC: IMF.
Djiwandono, J. Soedradjad, 1997. The Banking Sector in an Emerging Market: The Case of Indonesia, in Charles Enoch and John H. Green, Eds. Banking Soundness and Monetary Policy; Issues and Experience in Global Economy, Washington DC: IMF.
Djiwandono, J.Soedradjad, 1998. " Indonesian Financial Sector: Reforms, Development And Lessons, in The Asian Crisis: A New Agenda for Euro-Asian Cooperation, Jean-Claude Berthelemey and Tommy Koh, Eds, Singapore: Asia-Europe Foundation.
Edward, Sebastian, 1984. The Order of Liberalization of the External Sector in Developing Countries, Essays in International Finance, No 156, Princeton: Princeton University
Enoch, Charles and John H. Green, 1997. Banking Soundness and Monetary Policy: Issues and Experiences in the Global Economy, Washington DC: IMF
Feltenstein, Andrew and Saleh M. Nsouli, 2001. "Big Bang" Versus Gradualism in Economic Reforms: An Intertemporal Analysis with an Application to China, IMF Working Paper No. WP/01/98, Washington DC: IMF
Goeltom, Miranda S., 1995. Financial Liberalization, Capital Structure and Investment: An Empirical Analysis of Indonesian Panel Data, 1981-1988, Singapore: ISEAS
Hanna, Donald P., 1994. Indonesian Experience with Financial Sector Reform, World Bank Discussion Paper No. 237, Washington DC: The World Bank
Johnston, R. Barry, et al, 1997. Sequencing Capital Account Liberalization: Lessons from The Experiences of Chile, Indonesia, Korea, and Thailand, IMF Working Paper, No. WP/97/157, Washington DC: IMF
Johnston, R. Barry, 1998, "Sequencing Capital Account Liberalizations and Financial Sector Reform", IMF Paper on Policy Analysis and Assessment, No PPAA/98/8, Washington DC: IMF
Lindgren, Carl-Johan, et al., 1996. Bank Soundness and Macroeconomic Policy, Washington DC: IMF
McKinnon, Ronald I., 1973. Money and Capital in Economic Development, Washington DC: Brookings Institution.
McKinnon, Ronald I., 1991. The Order of Economic Liberalization: Financial Control in the Transition to a Market Economy, Baltimore, John Hopkins University Press.
Montgomery, John, 1997. The Indonesian Financial System: Its Contribution to Economic Performance, and Key Policy Issues, IMF Working Paper, No.WP/97/45, Washington DC; IMF.
Nasution, Anwar, 1998. "Big Bang versus Go Slow: Indonesia and Malaysia", Financial Reform in Developing Countries, Jose M. Fanelli and Rohinton Medhora, Eds., London: McMillan Press Ltd.
Prawiro, Radius, 1998. Indonesia's Struggle for Economic Development: Pragmatism In Action, Kuala Lumpur : Oxford University Press
Shaw, Edward, 1973. Financial Deepening in Economic Development, New York: Oxford University Press.
Sundararajan, V and Toma J.T. Balino, 1991. Banking Crisis: Cases and Issues, Washington DC: IMF
Williamson, John, and Molly Mahar, 1998. A Survey of Financial Liberalization, Essays in International Finance No. 211, Princeton: Princeton University

Singapore, November 13, 2001.

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*To be presented at the Asian Policy Forum Workshop on Sequencing Domestic and External Financial Liberalization, organized by the Asian Development Bank Institute, Beijing November 20-21, 2001.
1The impact of the Mexican crisis in January 1996 and the strengthening of yen in April 1996 occasioned the previous external shocks. In both occasions, the rupiah was weakened, but it recovered within days.
2I found the two books published by the IMF, Carl Johan-Lindgren, et.al, Bank Soundness and Macroeconomic Policy, Washington DC: IMF, 1996, and Charles Enoch & John H.Green, eds. Banking Soundness and Monetary Policy: Issues and Experiences in the Global Economy, Washington DC: IMF, 1997, plus an earlier book edited by V. Sundararajan and Tomas J.T. Balino, Banking Crisis: Cases and Issues, Washington, International Monetary Fund, 1991; are very instructive for those interested in this subject.
3See Preface and Part I of the book, Carl-John Lindgren et.al. , Bank Soundness and Macroeconomic Policy.
4See, Morris Goldstein and Dennis Weatherstone, The Asian Financial Crisis, Institute for International Economics, Policy Brief 98-1, March 30, 1998.
5Michel Camdessus, The Challenges of a Sound Banking System, Charles Enoch and John H. Green, Banking Soundness………p.539
6Carl-John Lindgren, et al. Bank Soundness and Macroeconomic Policy, ……p.5
7See, Carl-Johan Lindgren, et al., Bank Soundness… table 2, page 26. On the main issues confronting Indonesia in coping with banking system management and banking reform prior to the present crisis, see my paper, The Banking Sector in Emerging Markets: The Case of Indonesia, published in Charles Enoch and John H. Green, eds. Banking Soundness………, PP 335-352.
8Carl-Johan Lindgren, et al., Bank Soundness and Macroeconomic Policy,…….p.9
9See, for example, Ronald McKinnon, The Order of Economic Liberalization, (Baltimore: The John Hopkins University Press,1991)
10See Jagdish Bhagwati, 'The Capital Myth' in Foreign Affairs, May/June 1998, pp. 7-13.
11See, Andrew Sheng, The Crisis of Money in the 21st Century, City University of Hong Kong Guest Lecture, 21 April 1998.
12See also, Stanley Fischer, Banking Soundness and the Role of the Fund, in Charles Enoch and John H. Green, Eds. Banking Soundness…….p.23.
13See Manuel Guitian, Banking Soundness: The Other Dimension of Monetary Policy, in Charles Enoch and John H. Green, Eds. Banking Soundness and Monetary Policy,……. P 48.