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

A presentation at A One Day Seminar on Business, Economy and Finance: Indonesia's Road to Recovery, organized by PERMIAS, Clausen Center for International Business and Policy and International and Area Studies, University of California at Berkeley, March 27, 1999.



  • Beside my own subscription for new approaches to development, I would propose, at least for the present topic of our discussion, to go back to view development in a traditional way, that it is basically investment activity, irrespective of how do we define investment. In our economic jargon investment expenditure needs financing, which usually comes from saving. But, a developing country is usually faced with problem of wanting to invest too much in comparison to its capability to finance it through mobilization of saving. Another word, it faces with the saving-investment gap. Debt can be seen as a means of financing this gap, beside foreign direct investment, portfolio investment, grants and aids.

  • Over the years, the development of Indonesia tends to change from a government sector-led to a private sector-led. Viewed from the financing aspect, this shift had been accompanied by another shift in, at least some part of the source of financing, from a reliance on medium and long-term official loans to commercial and shorter term's borrowings. The shift had been facilitated by open and free flows of capital globally. However, it also had its own downside, which had clearly been exposed in the current crisis. So the questions that I would like to address here would be; what had been the role of debt in Indonesian development? What would be the prospect in the future development at the time when the world finance leans toward a new paradigm which still has to be determined, but basically maintaining an open financial system with free capital flows, but less prone to crisis.


  1. Since external debt, short-term in particular, has been singled out as one of the major problems that led to Asian crisis, more studies have been conducted to discuss about problems arising from or related to external debt. Indonesia is no exception. However, we should put the debt issues in Indonesia in a broader perspective by tracing historically the financing of its development.

  2. I have to admit that, it seems to be only recently that I used to explain to different groups of audience that Indonesia had been financing its development prudently, since government never borrowed domestically, and that it borrowed internationally only in funds with official development assistance (ODA) terms. That means, medium and long-term loans with some concessionary rates of interest. It was definitely the case, until some time in 1994-1995. But, soon after, the picture was changed drastically, when private sector debt - corporate in particular - was ballooning very rapidly. A similar change was happening to the engine of Indonesia's growth. Since mid eighties the development of Indonesia had been export-led. But actually by 1994/95 domestic economic activities had been contributing more to the GDP growth compared to exports. Despite the continuous policy of export-led development, in the last few years before the crisis, the actual engine for growth in Indonesia was the strong expansion of domestic sectors of the economy with heavy reliance on foreign sources of imports and financing.

  3. Foreign debt has always been playing important role in financing Indonesian development. However, prior to mid nineties, especially on the earlier part of Indonesia's effort for development, the government through successive five years -development plans, had played the major role of formulating and executing these plans, including financing aspects. The development plans could even be said as government sector plan. Sources of financing were coming from budget surplus as defined by the Indonesian government, i.e. the positive difference between government revenues and routine expenditures, and saving mobilization from the private sectors, both domestic as well as foreign. For the whole economy, total savings, both from the government as well as from the private sector, financed total investment expenditures. The rest of the S-I gap was financed by foreign sources of financing. To simplify the issue, the foreign sources of financing were coming from foreign direct investment, foreign grants and aids and foreign loans.

  4. I would argue that during the period that the government sector was dominating development activities, prudent financing had been generally exercised. Development finance had been done through budget surpluses - in the Indonesian definition of budgetary surplus - and ODA terms of foreign loans in the government sector. While in the private sector, financing through bank loans was, in general, met with public savings through the banking sector that was increasing rapidly. Foreign direct investments had been expanding healthily, while capital market started to grow only towards the end of the 1980's. During this period - from beginning of 1970's to mid 1990's - foreign debts were mostly government's debt with ODA terms.

  5. It may be telling to say that even at nearly the end of this period, when the ballooning private (short-term) debt was not publicly recognized yet, a shock in the currency market was not virulent. What happened in the Jakarta currency market in January 1995, as part of the 'tequila effect' the currency market was hit, but Bank Indonesia could stabilize the rupiah within days. And so was in mid 1995 when market players was nervous due to the strengthening of yen when they knew that 40% of Indonesian debts was to Japan. This was in contrast to what happened in July 1997, which I will discuss later.

  6. The shift from a government sector dominant to private sector dominant of development happened in 1994/95, even though the process had started in the beginning of the nineties. The shift from government dominant to private dominant was so subtle that we hardly notice it. In a way it may not be noticeable, since the government presence is still very much felt every where. It is even more conspicuous in social and politics. But, the fact remains true that the private sector dominate more economic activities. In the financial sector the picture is very clear. In the banking industry, in terms of funds mobilized and loans provided, the role of the private banks which was less that 25% in the seventies became more than 60% immediately before the crisis. In terms of number of banks, of course, the majority of banks in Indonesia are privately owned. With respect to foreign debts, out of $140 billion of national debts at the time the GOI signed the first Letter of Intent to the IMF in November 1997, $80 billion belonged to private.

  7. Both the government policy as well as the globalization process that came strongly in the nineties encouraged the increasing role of the private sector. With increasing needs for new development in telecommunication, energy, roads, railroads, and other infrastructures in Asia's emerging economies, suddenly new business opportunities were widely opened. Because of the nature of the projects as well as the new modes of doing business and finance in the new era of globalize economy, these investments were either done by private corporations on behave of the respective governments or jointly done by governments and private corporations. The Suharto government started to invite private corporations in infrastructure development in the early nineties. It would be clear on a later date that this is part of the crony capitalism practices that his government was notoriously known. The increasing role of the private sector had been more prominent in the financing aspect of infrastructure development. Different schemes of financial engineering would make the private corporations, as well as the state enterprises, incurring higher and higher exposures externally. In turn, this had been making the national economies more fragile in a world economy that became more interdependent as well as unstable. This had also been noticed recently as a factor in causing the panic in the financial markets and the crisis.

@ Professor of Economics, the University of Indonesia, Jakarta, currently a Visiting Scholar at the Harvard Institute for International Development (HIID), Cambridge, MA.


  1. As I said before, with the shift of development activities toward more private sector dominant, the reliance on foreign debt was increasing. This did not mean that the government financing of the development was actually declining. The main reason was because in the next step of development process, the most crucial factor of development was building of infrastructures, physical, institutional as well as financial, that required sizable investment expenditures. The financing need was much larger than the national saving, even though national saving was high, as it had been the case in many Asian economies. Thus, the financing had to come from foreign source. And funds were available in the world market then. This was the objective condition that ultimately pushed emerging economies to heavily resorting to external funds for financing development. But, this had not been without adverse implications, as we observed when the Asian crisis developed.

  2. As it had been argued by many, capital flows were closely related with the Asian crisis. As reported in the IMF Survey on International Capital Markets, aside from their distinctive features, there were similarities between Asian crisis and the previous crises, i.e.the debt crisis in the 1980's and the Mexican crisis in 1994/95. The similarity was that the periods leading to each of the crises were characterized by surges in private capital inflows and the emergence of large unhedged exposures of domestic borrowers. Here, the 'herd instinct' argument of the corporate sector and the role of 'confidence' in investment decision of Keynes, had been well taken. They were valid for the domestic borrowers as well as the foreign lenders or investors. The herd instinct worked both on the capital inflows, in the period prior to the crisis, as well as the capital outflows, during the crisis. Reversal flows, that were very substantial, happened due to a shift in market confidence.

  3. The Asian crisis demonstrated that the herd instinct had been dictating the domestic borrowers as well as foreign creditors. Some argued that investors had been putting their money in the emerging economies because of their belief that the host governments would not allow banks to collapse. The usual moral hazard argument. But, when the expectation did not materialize, meaning that these governments did fail banks from whatever reasons, they were shocked. I found this does not make much sense. May be these people have to accept that their assumption - about the presence of moral hazard, i.e. that host governments or IMF will come to bail out banks - was wrong, and not blaming others. May be the conventional wisdom that the market or the private sector knows better is not always valid. Also the perception that bankers know better (than corporate companies) or that foreign players know better (than indigenous market players) have not been right in the first place.

  4. With a strong performance in the Indonesian economy and the weakening of economies in the debtor countries, Japan and Europe in particular, it was attractive for investors from these countries to invest in Indonesia and other emerging countries. Investment was dominated by 'passive investors', who followed others (the leader) like herd. For Indonesian corporations, the high rates of interest at home, had encouraged them to borrow abroad instead of borrowing domestically. The lenders' assumption about the presence of government guarantee, despite the fact that there was no explicit nor implicit guarantee in the system, made them lend their money imprudently. (How about credit supervision from the lenders' country?) Furthermore, the borrowers' assumption about the government commitment to a 'fixed or pegged exchange' policy, despite the practice of creeping depreciation and continuous widening of the intervention bands in Indonesia, drove Indonesian corporations imprudently borrowing abroad, unhedged. The bigger the gap between the perception and the reality, the bigger the gap between domestic and international rates of interest, the bigger was the external exposures of the private sector. When Bank Indonesia floated the rupiah in mid August 1997, all these expectations were ruined, and all the parties involved in the transactions were in trouble. Corporate sector debts have been contributing significantly to the Indonesian crisis. Michael Pomerleano of the World Bank in his article in Viewpoint argued that the Asian crisis rooted in the corporate sector of their respective economies. A combination of high-debt, high risk model of economic development and lack of financial and institutional discipline in an environment without an adequate prudential framework results in the mix of currency, corporate and banking crisis in East Asia.

1Charles Adams et al, International Capital Markets: Development, Prospects and Key policy Issues, (Washington DC: IMF), September 1998.


  1. Debt has been part of financing development in Indonesia. It was part of the success story of Indonesian development with prudent borrowing in the past. However, in the recent crisis, debt was also part of the major problems, as short-term corporate debts seemed to be its lynchpin. On the other hand, the crisis is not just a debt crisis. As I have been arguing on different occasions, Indonesian crisis is a full-fledged crisis, involving practically, all aspects of people's lives. Indeed, Indonesia's crisis that was purely a currency shock as part of the financial panic in Southeast Asia, when it started, through a contagion process, had been spreading to become banking crisis and economic crisis, due to structural weaknesses in banking. Furthermore, the economic crisis was very rapidly spreading to social and political one, also due to structural weaknesses in them. This, in my view, is the reason why Indonesia has been the hardest hit among the crisis countries. The weak social structures of Indonesia could easily be seen from various social upheavals and riots which have been historical in Indonesia. 4

  2. Why the muddling through of a process in addressing debt problem? I believe this is due to the lack of understanding about the issues, aside from the complexity of the problem itself. I guess, before we could talk about the future role of debt in the Indonesian development, we should discuss about how to get out of the crisis first. But, the role of debt in the crisis was only fully recognized after it hit the banking sector and payment system was incapacitated. It has been part of what we learned from the crisis with the benefit of hindsight. Much criticism was launched at the lack of data provided by Bank Indonesia on private sector debt in the early part of the crisis. (I should put on record that at the time the Government of Indonesia/GOI signed the first letter of intent to the IMF, the debt figure of $140 billion and the composition of government and private debt were put in the document). But, even the IMF was not, in the beginning, insisting on designing a policy to address the problem of corporate debt. The only stipulation on this matter was that the government should not bail out corporate debt, period. All the schemes for addressing private sector debt which ended up in the form of the Jakarta initiative a year later, were discussed only during preparation of the second LOI in January 1998. As short term external corporate debt was the lynchpin of the crisis, programs for addressing the crisis could not be effective without taking this into consideration. We were too late in realizing this as compared to Korea and Thailand. In both Korea and Thailand steps to cope with debt issues were treated much earlier, and a formula was produced much sooner. In Indonesia, in spite of the fact that the first LOI was signed in October 1997, problems of corporate debts were only meagerly dealt with in the second LOI of January 1998. Some sort of understanding between the creditors and debtors was only reached in June 1998 and a framework for dealing with the issues were only produced in September 1998 with a document known as the Jakarta Initiative. This is another explanation of why Indonesia was the hardest hit.

  3. As it was stated before, the crisis is a full-fledged one. In this condition, any step to address a particular problem has to be evaluated in its relation with the whole issues. However, it is impossible to deal with all aspects and all problems of the crisis simultaneously. Prioritizing has to be done, and wherever feasible, sequencing is in order. But, to get out of the crisis, some degree of confidence has to be obtained by the national leadership, a legitimate government. An open and fair general election for members of Parliament plus an open and fair presidential election is an important step, which could lead to this. Whether the upcoming election could provide Indonesia with legitimate government is still unclear. I found that the enthusiasm of many, including the US government officials and some multilateral institutions assisting Indonesia, to take for granted that the upcoming election will produce a democratically elected government of the fourth largest country in the world still have to be accepted with a cautious optimism. That is what all of us hope and wish. But, all parties involved still have to work very hard to make it into reality.

  4. The economic problems facing Indonesia are enormous. However, they are more straightforward. Financial and economic problems could definitely be solved once social and political problems disappear. With respect to the debt problem itself, it is argued here that, debt problem cannot be left out in any effort to address the crisis. However, it is also true that effort to solve debt problem has to be in its broader context of economic and other issues.

  5. The problem of debts in Indonesia at present is basically the external debts of the corporate sector, in particular the short-term ones. A detailed data should be consulted, but the private external debts in Indonesia are predominantly private corporation debts. In addition, they are predominantly short term and unhedged. The major lenders are Japanese and European banks and to some extent, Korean and American banks. These features should be more carefully assessed at least as to why they are different from the Korean or Thailand case. Most corporate sector's debts in Thailand and Korea were made through banks, such that their external debts are also banks' exposures. In Indonesia, the major parts of corporate sector's external exposures were done through direct borrowing from foreign banks or private placement with securitization.

  6. The fact that corporate sector's debts constitute the major part of Indonesia's debts does not mean that debt problems could be settled independent of other solutions. In fact, for Indonesia, the solution to this problem is inseparable from the solution of the banking sector. Bank restructuring and recapitalization have to go hand in hand with corporate debt restructuring. Even though private debts in Indonesia predominantly corporate debts - either due to direct borrowing technique or through finance companies - due to conglomeration and cross ownership, one way or another they are connected with banking sector. Corporate debt problem in Indonesia is very serious and any program to address the crisis has to include steps to take to address corporate debt issues. Since we accept that banking restructuring is a must for Indonesia, it follows that corporate debt restructuring has to be included in the program.

  7. Looking to the near future, with increasing government debts from multilateral agencies and some bilateral countries, as parts of programs for currency and economic stability, the Indonesian debt stock will be increasing. In September of last year, the Economist Intelligence Unit (EIU) estimated that by 2001 Indonesian foreign indebtedness would amount to $175 billion. Definitely a staggering amount in view of the fact that our GDP in US dollar will be much less than it was before crisis.

2 See Michael Pomerleano, 'Corporate Finance Lessons from the East Asian Crisis', Viewpoint, September, 1998.
3 As we notice, there is a polarization of analysis about the origin of the Asian crisis between those who argued that the crisis is externally originating from financial panic triggered by a shift in market confidence (financial panic theory in the Keynesian tradition as demonstrated by Kindleberger), and others who argued that the crisis is domestically originating from the downside of crony capitalism practices. I hold a view that the Indonesian crisis is a combination of the two; externally triggered, but due to structural weaknesses in Indonesia's financial, social and political system, Indonesia suffered the most.
4 I presented a paper in a panel organized by The american Society of International Law (ASIL), Race, Riots and Money: The Role of the Bretton Woods Institutions in the Indonesian Financial Crisis, Washington DC, March 26, 1999.


  1. Debt problem in Indonesia has been historical. Lately, aside from its frightening magnitude, its composition and characteristics made debt problem in Indonesia complex and very serious. Even if in the past Indonesia could claim to be prudent in using foreign debt to finance development, it has not been the case since the nineties. Nationally, even though total savings have not been bad at all, highly leveraging has been a common practice in the corporate sector in particular. Nationally I think we have been living beyond our means.

  2. With heavy reliance on external loans to deal with problems arising from the crisis, plus a drastic decline of GDP in dollar terms, Indonesia will be even further deep in the category of a very high debt country. Some estimate put the figure of foreign indebtedness by 2001 to be $175 billion; and GDP per capita will be less than 70% of its 1997 level in dollar terms in 2002. (EIU, September 1998).

  3. Why process of debt resolution and banking restructuring in Indonesia, compared to Thailand and Korea, is so slow? Dr. Gray of the World Ban, listed the vulnerability of corporate sector in debt restructuring which include, concentrated ownership (58% of Indonesian corporations are owned by 10 families), high corporate sector debt (using recent rate, corporate debt is $67 billion external and $51 billion domestic), poor corporate governance and some macroeconomic factors. (Presentation at an HIID seminar). I would add one to the list, at least with respect to banking restructuring that, political or non-technical considerations has been a complicating factor for a credible policy acceptable by the market. The latest banking policy had, of course, been good news. However, to have a high expectation as asking the banking sector to start serving the real sector aggressively, as some had voiced after the step was announced, shows not having a good understanding about the problem. One should realize that, after the last policy initiative, the remaining banks to serve the economy comprise of more than seventy healthy small banks and a number of large unhealthy banks (all state banks plus a couple of BTOs). A more daunting task is still waiting, i.e. dealing with the second group of banks, before we can expect the banking system to start its slipery path of recovery.

  4. Debt problem of emerging countries is very serious, not just for corporate sectors and governments of the debtor economies, but also for the lender countries. One lesson that the recent crisis seemed to tell us is that heavy reliance on external debts, especially short-terms, is disastrous for financing development. In this globalized economy and finance, a sustainable system of financing development that includes external debts requires action by debtor countries suggested in the so called 'new international financial architecture'. In fact, as Stanley Fischer rightly stated, changes would require action by three key sets of players in the international system; first, governments and private sector in emerging market countries; second, governments and private sector in the leading industrialized countries where the capital flows originate; and third, international institutions. 5

Cambridge, March 19, 1999.

5 Stanley Fischer, Reforming the International Monetary System, David Finch Lecture, Melbourne, November 9 1998