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Indonesia Financial Reform
The president's technocratic advisers on financial
policy, who
had unsuccessfully resisted growing government regulations
during
the 1970s, spearheaded the return to market-led
development in the
1980s. The financial sector is often the most heavily
regulated
sector in developing countries; by controlling the
activities of
relatively few financial institutions, governments can
determine
the direction and cost of investment in all sectors of the
economy.
From the 1950s to the early 1980s, the Indonesian
government
frequently resorted to controls on bank lending and
special credit
programs at subsidized interest rates to promote favored
groups.
Toward the end of this period, the large state banks that
administered government programs were often criticized as
corrupt
and inefficient. Sweeping reforms began in 1983 to
transform
Indonesia's government-controlled financial sector into a
competitive source of credit at market-determined interest
rates,
with a much greater role for private banks and a growing
stock
exchange. By the early 1990s, critics were more likely to
complain
that deregulation had gone too far, introducing excessive
risk
taking among highly competitive private banks.
Like many developing countries, the Indonesian
financial sector
historically was dominated by commercial banks rather than
by bond
and equity markets, which require a mature system of
accounting and
financial information. Several established Dutch banks
were
nationalized during the 1950s, including de Javasche Bank,
or Bank
of Java, which became the central bank, Bank Indonesia, in
1953.
Under Sukarno's Guided Economy, the five state banks were
merged
into a single conglomerate, and private banking virtually
ceased.
One of the first acts of the New Order was to revive the
legal
foundation for commercial banking, restoring separate
state banks
and permitting the reestablishment of private commercial
banks and
a limited number of foreign banks.
During the 1970s, state banks benefited from supportive
government policies, such as the requirement that the
growing state
enterprise sector bank solely with state banks. State
banks were
viewed as agents of development rather than profitable
enterprises,
and most state bank lending was in fulfillment of
governmentmandated and subsidized programs designed to promote
various
economic activities, including state enterprises and
small-scale
pribumi businesses. State bank lending was
subsidized
through Bank Indonesia, which extended "liquidity credits"
at very
low interest rates to finance various programs. By 1983
such
liquidity credits represented over 50 percent of total
state bank
credit. Total state bank lending in turn represented about
75
percent of all commercial bank lending. The nonstate
banks--which
by 1983 numbered seventy domestic banks and eleven foreign
or
joint-venture banks--had been curtailed during the 1970s
by
licensing restrictions, even though they offered
competitive
interest rates on deposits and service superior to that
offered by
the large bureaucratic state banks. Bank Indonesia also
imposed
credit quotas on all banks to reduce inflationary
pressures
generated by the oil boom
(see Monetary and Exchange Rate Policy
, this ch.)
The first major economic reform of the 1980s permitted
a
greater degree of competition between state and private
banks. In
June 1983, credit quotas were lifted and state banks were
permitted
to offer market-determined interest rates on deposits.
Many of the
subsidized lending programs were phased out, although
certain
priority lending continued to receive subsidized
refinancing from
Bank Indonesia. Also, important restrictions remained,
including
the requirement that state enterprises bank at state banks
and
limitations on the number of private banks. By 1988 state
banks
still accounted for almost 70 percent of total bank
credit, and
liquidity credit still accounted for about 33 percent of
total
state bank credit.
In October 1988, further financial deregulation
essentially
eliminated the remaining restrictions on bank competition.
Limitations on licenses for private and foreign
joint-venture banks
were lifted. By 1990 there were ninety-one private
banks--an
increase of twenty-eight in a single year--and twelve new
foreign
joint-venture banks, bringing the total foreign and
joint-venture
banks to twenty-three. State enterprises were permitted to
hold up
to 50 percent of their total deposits in private banks.
Later, in
January 1990, many of the remaining subsidized credit
programs were
eliminated.
The extensive bank deregulations promoted a rapid
growth in
rupiah-denominated bank deposits, reaching 35 percent per
year when
controlled for inflation in the two years following the
October
1988 reforms (for value of the
rupiah--Rp--see Glossary).
This
rapid growth led to concerns that competition had become
excessive;
concern was heightened by the near failure of the nation's
second
largest private bank, Bank Duta. The bank announced in
October 1990
that it had lost more than US$400 million, twice the
amount of its
shareholders' capital, in foreign exchange dealings. The
bank was
saved by an infusion of capital from its shareholders,
which
included several charitable foundations chaired by Suharto
himself.
The spectacular crash of Bank Summa in November 1992 was
not
protected by Bank Indonesia. Its owner, a highly respected
wealthy
businessman, was forced to liquidate other assets to cover
depositors' losses.
Unrestricted transactions in foreign exchange by
Indonesian
residents had been a unique feature of the financial
sector since
the early 1970s. While many developing countries attempt
to outlaw
such so-called capital flight, the New Order continued to
permit
Indonesian residents to invest in foreign financial assets
and to
acquire the foreign exchange necessary for investments
through Bank
Indonesia without limit. Commercial banks in Indonesia,
including
state banks, were also permitted since the late 1960s to
offer
foreign currency--usually United States dollar--deposits,
giving
rise to the so-called Jakarta dollar market. By 1990 20
percent of
total bank deposits were denominated in foreign currency.
This
freedom to invest in foreign exchange served the financial
institutions well. During the 1970s, when banks' domestic
credit
activities were heavily restricted, most banks found it
profitable
to hold assets abroad, often well in excess of their
foreign
exchange deposits. When demand for domestic credit was
high, banks
resorted to international borrowing to finance expanding
domestic
loans. To control the domestic supply of credit by
plugging the
offshore leak, in March 1990, Bank Indonesia issued a new
regulation that limited the net foreign position of a bank
(the
difference between foreign assets and liabilities) to 25
percent of
the bank's capital.
Prior to bank reforms in October 1988, some private
banks were
essentially the financial arm of large business
conglomerates and
consequently did not make loans to businesses outside
those
connected with the bank's owners. The 1988 bank reforms
limited
loans to businesses owned by bank shareholders. When many
of the
government-subsidized credit programs targeted to small
businesses
were eliminated in January 1990, the government required
banks to
lend a 20 percent share of their loan portfolio to small
businesses, defined as those businesses with assets,
excluding
land, worth less than Rp600 million (about US$300,000).
This aspect
of financial reform ran counter to the overall effort to
improve
bank efficiency, since the rule applied to all banks
regardless of
their expertise in small-scale lending. However, the
policy
reflected the government's persistent concern that the
public might
perceive the benefits of economic growth as limited to the
wealthy
few.
One of the most striking outcomes of financial reform
was the
revival of the Jakarta stock market in the late 1980s.
Established
in 1977, the stock market had become lifeless during the
early
1980s because of extensive regulation of stock issues and
price
movements. In conjunction with substantial bank reforms,
many
restrictions on the Jakarta Stock Exchange were lifted in
the mid1980s , broadening the range of firms that could issue
equity and
permitting stock prices to reflect market supply and
demand. To tap
the growing international interest in Asian investments,
foreign
ownership was permitted for up to 49 percent of an
Indonesian
firm's issued capital. The market's response to these
reforms was
dramatic. The number of firms listed on the exchange rose
from 24
in 1988 to 125 in January 1991, and the market
capitalization--the
total market value of issued stocks--reached more than
Rp12
billion. Although this amount of market capitalization was
less
than 15 percent of the volume of bank credit to private
firms, the
stock market promised to become an increasingly important
source of
finance.
Data as of November 1992
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