Coping with the global financial crisis: Indonesia's experience during 2008-2009


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Coping with the global financial crisis: Indonesia's experience during 2008-2009

  1. 1. COPING WITH THE GLOBAL FINANCIAL CRISIS : INDONESIA’S EXPERIENCE DURING 2008—2009* By: Adriyanto Introduction As an open economy Indonesia and other major economies in the Asian region could not escape from the negative impact of financial crisis, which has happened in both the regional and global scope. In 1997, financial crisis which started in its neighboring economies spread quickly to Indonesia. Many economists at that time blamed the weak control and monitoring of the financial system as the cause of Indonesia’s vulnerability to the crisis. In 2008 the global financial crisis which started in the US as a result of a “bubble economy” that drove the prices of property up and triggers the failure of the sub—prime mortgage market, has caused a negative spill-over effect to other major economies such as Indonesia. This particular crisis has even resulted in negative growth in many advanced Asian economies such as Singapore and Japan. This time however, with a stronger economic fundamental, the effect of this particular crisis on Indonesia's economy is relatively insignificant. Acting together with its G20 counterparts Indonesia has managed to stem the prolonged negative effect of the crisis. Indonesia’s experience in coping with the recent financial crisis has shown the need of synergy between domestic and global economic policies. Background of the Crisis In order to manage any crisis properly, an in-depth understanding of the crisis in hand is necessary. An anatomical analysis of the crisis is therefore needed to determine causes, spill-over mechanism and short as well as long term effect expected. Knowledge on these aspects of crisis is necessary to enable policy makers to come up with solutions which are integrated, focus, and timely. *This paper was originally presented for Asian Parliamentary Assembly Session and the views expressed in this paper are those of the authors and do not necessarily reflect the views of the his afi'Iliates. .
  2. 2. The recent liquidity crisis which takes its root in the US, quickly spread to Europe, taking an advantage of the advancement in information technology, which not only drives the global capital mobility but also accelerate the spread of financial crisis to the rest of the interconnected economics. 10 years following the Asian financial crisis, United States suffers a financial crisis due to the failure of the Sub-Prime Mortgage Market. Both of these crisis has similarities (Sheng, 2009), both are preceded by the bubbling of assets value, over—liquidity in the financial market and large capital inflow coupled by lack of supervision in the high risk financial market transaction. Investment innovations in the financial market, which are not followed by fundamental changes in regulatory framework of the financial sector has contributed to the recent crisis. Innovation such as the “shadow banking system” consisting of a network of non-banking institutions, which provide credit but does not accept saving and deposit as banks do, are excluded from the banking supervision system. The absence of supervision instruments for this particular business line has created a moral hazard among market stakeholders resulted in a mismatch of financing practice where short term loan is utilized to financed long term speculative investment such as the mortgage backed securities. When property value plummets it triggers a chain reaction that leads to the failure of credit compliance among mortgage takers. When the market disruption occurs and became chronic many financial institutions which are part of the shadow banking system, such as Bear Stem and Lehman Brothers collapsed. The failure of the financial sector supervision system to regulate and monitor the progress of financial system innovative practices such as the shadow banking has lead to a serious crisis which threatened the economic growth and development of other economies. Paul Krugman (2009) describes this failure as a “malign neglect. This bitter experience has demonstrated the crucial importance of having a supervisory entity that understands the inner—working of the financial market and able to anticipate and control the development of high risk financial instruments and practices. The Impact of the Global Financial Crisis
  3. 3. The recent global financial crisis has impacted economies in numerous ways, both social and economical. In 2009, the World Bank predicts that the recent Global Financial Crisis will create an additional 53 million poor‘, this is due mainly to the decline of the global economic growth. Food and commodities crisis are expected to contribute to the worsening of this condition which the World Bank has coined as “3F’ (financial collapse coupled with increase of food price and fuel price). The increase of food and staple commodities followed by the increase of fuel price may lead to high inflation, a condition where the less fortunate member of the communities will suffer the most. Eventually the recent global financial crisis will lead to a significant setback in the MDGs achievements. Acute liquidity crisis in the global financial market has caused a slow—down of economic progress in many major economies especially in the US and Europe. This is clearly illustrated by the fact that in 2009, a number of economies such as Japan and America still have a negative economic growth. Despite the decline of economic growth in advanced economies, developing and emerging economies suffers the same problem due to the volatility of exchange rates that triggers capital outflow. In addition to the volatility of exchange rates, credit crunch, weakening of global demands, especially those which comes from US and Europe, has resulted in a decline of developing economies export values. Despite the variety of scale in which economies are impacted by the crisis — this may depend on the exposure of the economies towards the global financial market — measures to overcome the impact of the crisis must be carried out in parallel with global TCSPOIISCS . Crisis Handling by the G20 The magnitude of the crisis, which originated from the US financial sector is so huge that it has disrupted the global financial system and as a result there is no single economy in the world, which is completely isolated from the effect of the crisis. 1 The estimates adopts the classification of the poor of those who live under $2 per day
  4. 4. Based on the principal that any global crisis should be dealt through a collective global effort, Indonesia together with its G20 counterparts has agreed in adopting a number of agreement includingzz a. Restorating Global Economic Growth through ; 0 Countercyclical policies which are carried—out through expansionary fiscal and monetary measures covering among others; the provision of fiscal stimulus and controlling the growth of interest rate. In this respect the US government has issued a stimulus package in the value of USD 787 billion to help accelerate its economic growth while Japan and UK has each issued a stimulus package valued for USD 100 billion and 30 billion respectively. Indonesia launched around $7 billion fiscal stimulus. 0 Non-Protectionist Agreement by maintaining an open trade and investment regime. In addition, the G20 member economies have also agreed to step up trade financing to encourage the growth of international trade. 0 Strengthening the capital position of International Financial Institutions to help overcome the gap for global development financing. The World Bank estimates that financing gap for developing economies has reached between USD 350-365 billion in 2009 due to capital reversal. In this respect Indonesia has played a significant role in supporting the capital increase of IFIs where it has succeeded in championing the increase of ADB’s capital three fold from USD 55 billion to USD 165 billion, b. Strengthening of Global Financial System 0 G20 member economies have agreed that failure in providing adequate supervision and regulation is a key source of the recent global crisis. To overcome this issue efforts should be made to develop a stronger and more reliable regulatory and supervisory framework for the financial sector. 0 A number of concrete measures have been taken, which are among others; the establishment of the Financial Stability Board (FSB) with bigger mandate to replace the role of Financial Stability Forum (FSF) and expanding membership to include G20 2 Summarized from G2OLeader statement in London summit, on April 4 2009
  5. 5. economies, existing FSF member economies, Spain and the European Commission. With the establishment of “a more empowered” FSB comes the issue of coordination among Supervisory and Standard Setting Bodies. In this respect the G20 has acknowledge the need to have a stronger collaboration between IMF and FSB especially in the development and implementation of early warning system for the financial sector. Several financial sector related policies which have been agreed, are among others ; the expansion of supervision to include systemic financial institutions, regulating transparencies and exchange of data for the purpose of taxation as well as enhancing supervision on international rating bodies. Swift and coordinated effort carried out by G20 member economies has yield a positive result, shown by the improvement in the economy of a number of developing countries. For Indonesia, economic growth has achieved 4.3% in 2009 which would be only 2.9% without stimulus. IMF revised up the forecast of global economic growth for 2010 to 2.5% despite the slow global economic recovery. Along with IMF, the World Bank forecast global economy will grow by 2.7% in 2010 and 3.2% for 2011. In light of this development, G20 has initiated a number of exit strategy measures to help effected economies to shift from crisis impact mitigating strategies to economic growth recovery strategies. A number of strategies have been taken through among others3; The establishment of stronger, balanced and more sustainable framework for development. This is needed to ensure that development is conducted based on a solid economic foundation which is able to generate employment. With a standardized framework member economies can compare each other progresses based on the agreed upon framework. Improvement of the capital and financing standard, as well as standard for international compensation, aimed to overcome the excessive speculative practices and improving the over the counter market. 3 Excerpted from G20 Leaders Communiqué in Pittsburg, September 2009.
  6. 6. 0 Initiation of budget saving measures through gradual decrease of energy subsidies while ensuring the protection of the poor. Collective and strong policy coordination among G20 members has successfully recovered investor confidence. The State street Investor Confidence Index4 denotes a significant rise after G20 Leaders committed a number of policy actions as declared in April 2009 in London. March index was 95.2 and climbed up to 10.32 in April, 108.5 in May and persistently climbed to 119 in July. This may indicate investors regained their confidence for sustaining investment. Crisis Handling Measures in Indonesia Indonesian Banking sector is relatively unaffected by the crisis, which originated from US Sub Prime Mortgage Market failure, this has much to do with the fact that Indonesia’s banking sector has no exposure towards this particular type of financial market. Indonesia’s banking sector however, has suffered from the lack of access towards credit lines in the intemational market, affecting its ability to disbursed fund in the domestic market and driving the interest rate up. The drain of liquidity has led to credit crunch and pushed interest rate up further and hurt real sector. Although the banking sector did not suffer significantly from the crisis, the pressure generated from the capital outflow has threatened Indonesia’s Economy, where the international reserve has plummeted by 15%. In July 2008 Indonesia’s foreign currency reserve was still at the level of USD 60.6 billion and this has decreased significantly to USD 51.6 billion in December 2008. The loss of confidence among investors and financial market illiquidity has triggered capital outflow, exchange rate volatility and pushed inflation up further. In addition to consistently adopting and applying G20 agreed upon strategies, the government also strived to overcome the threat of the global crisis through three main crisis mitigating policies, which are; 4 The State Street Investor Confidence Index measures investor confidence on a quantitative basis by analyzing the actual buying and selling patterns of institutional investors. The index assigns a precise meaning to changes in investor risk appetite: the greater the percentage allocation to equities, the higher is risk appetite or confidence. A reading of 100 is neutral; it is the level at which investors are neither increasing nor decreasing their allocations to risky assets. .
  7. 7. 1. Improving market confidence through increasing domestic market liquidity through among others; decreasing the level of bank’s statutory reserve from 9.01% to 7.5% and decreasing the level of the bank’s statutory reserve in foreign currency from 3% to 1%. 2. Increasing foreign currency reserve through both bilateral and multilateral financing (World Bank, IDB, JBIC) as well as seeking swap facility from central banks of partner economies such as the Bank of China and the Bank of Japan. In addition, the government also seek financing for its exports through the provision of export bills discounted facility with recourse effective since November 1 2008. This measure has been followed by the decrease in export levies for crude palm oil from 2.5% to 0% effective since the same date as the discounted facility. 3. Improving the monitoring and surveillance of economic activities by the prevention of illegal imports through the issuance of regulation limiting the import of garments, electronics, food and beverages, children toys and shoes starting from November 2008. As an addition, through the minister of trade decree an inter-departmental task force has been established to help strengthened the surveillance and monitoring of the flow of these commodities. Government has strived to overcome the liquidity problem in regards to its financing needs from both domestic and foreign sources. Through a financing package provided from the World Bank which was approved in March 2009, in the form of a stand by precautionary loan facility called the Deferred Drawdown Option (DDO) as well as stand—by loan from ADB, Australia and Japan, Indonesia strengthened its reserve buffer and fiscal financing. The existence of this stand by precautionary facilities has helped boost investor’s confidence towards the country’s economic development sustainability in times of crisis. In the spirit of financing diversification, Indonesia’s has strived to diversify its financing resources and thus in addition to bilateral and multilateral financing already secured Indonesia also supports the establishment of regional financing instrument through a regional pool of fund under the Chiang May Initiative Multilateralization (CMIM) which is basically a multilateral swap contract among ASEAN member economies.
  8. 8. Govemment’s targeted and systematic polices has successfully resulted in positive perception in the market. Nielsen’s Global Consumer Confidence Index reported Indonesia topped among 50 countries at 104 points for half of 2009, followed by Denmark (102 points) and India (99 points). Market perception toward Indonesia’s economy is getting robust as shown by Nielsen’s survey in the first quarter 2010, confidence rose to 116 for Indonesia. Supported by strong economic fundamental and conducive domestic politics situation, Indonesia recorded positive growth among few Asian countries. Conclusion Global crisis handling by the G20 economies has demonstrated the effectiveness of working collectively. Policy coordination among economies is a crucial step in overcoming the negative impact of a global crisis, mutual interest must be prioritized and each economies must strive to avoid adopting “beggar thy neighbor” policies, an expression in economics describing policy that seeks benefits for one country at the expense of others. The more inter-connected economies, where economic borders have faded, have eased the transmission of other country’s economic difficult or better known as contagion effect. A regional and global economic cooperation to monitor the development of economic and financial sector through early warning system is crucial to ensure country can anticipate better future crisis. In regards to this ever increasing vulnerability world economies must collaborate not only to ensure an integrated and effective solution towards global crisis but also to establish an effective global surveillance and monitoring system. In addition to this, dynamic approach towards policy making should be taken to accommodate fast pacing nature of the global crisis, furthermore policies taken post crisis will be different from those taken during the crisis, the accurate insight on where the economy is in the stages of crisis will be very helpful in designing an accurate and effective crisis response strategy. Last but not least the anatomy of the crisis should be carefully scrutinized to determine the main sources of the crisis as well as to identify affected areas and potential responses to be applied 8
  9. 9. simultaneously. Efforts must be undertaken in parallel with other policy making bodies within the economies and throughout the world. Indonesia has coped with detrimental effects of the economic turmoil and crisis of confidence that has disrupted the global financial system. Maintaining market confidence was obviously one of critical factors to mitigate the crisis.
  10. 10. Reference G-20 Leader Communique, London, April 2009 G—20 leader Communique , Pittsburg, September 2009 Krugman, Paul (2009). The Return of Depression Economics and the Crisis of 2008. W. W. Norton Company Limited. ISBN 978-0-393-07101 —6 Global Consumer Confidence, Concerns and Spending, a global Nielsen consumer reporl, downloadable at http2// pt. nielsen. com/ documents/ tr_09O5NielsenGlobalConsumerConfidenceReportl stHalf09.pdf Sheng, Andrew, 2009, From Asian to global financial crisis, Cambridge university press, hal—376. World Bank, Financial Crisis Could Trap 53 Million More People in Poverty, World Bank News, February 2009 10