How Indonesia and Singapore Were Affected by and Confronted the Asian Financial Crisis - Case Study Example

How Indonesia and Singapore were affected by and confronted the Asian Financial Crisis of 1997 and the Global Financial Crisis of 2008 and later Introduction The Asian financial crisis of 1997 unfolded in various overlapping phases, starting in Thailand on 2 July 1997 when the Thai baht was allowed to float, and spreading to other Southeast Asian nations (Haggard 2000, p. 4). Many countries including Thailand, Indonesia and Korea experienced a harsh economic downturn throughout 1998. Others like Singapore were however able to recover quickly following policy responses adopted to deal with the crisis. This paper compares the experiences of two nations – Indonesia and Singapore during the 1997 crisis and also discusses the countries’ situation during the 2008 global financial crisis (GFC) and thereafter. It is noted that during the GFC, Indonesia was again affected because of its open economy. However, it is revealed that the impact of this crisis was not as pronounced on Indonesia as it was on Singapore because of Indonesia’s strong economic fundamental. However, the 2008 crisis resulted in negative growth in many advanced Asian economies including Japan and Singapore. The discussion also touches on how Indonesia and Singapore dealt with the GFC and the situation thereafter. Experiences of Indonesia and Singapore during the 1997 Asian financial crisis Indonesia’s experience Indonesia is one of the countries that were hardest hit by the 1997 Asian financial crisis. By mid 1997, Indonesia, Korea and Thailand were the three nations most severely troubled by the crisis, and it is the same countries which experienced a harsh economic downturn throughout 1998 (Radelet & Sachs, 2000, p. 131; Corsetti, Pesenti & Roubini 1999, p. 69). This point is reiterated by Martinez-Diaz (2006, p. 395), who notes that Indonesia ‘suffered by far the most traumatic experience of all countries affected by the regional shock’, and Ginting and Aji (2012, p. 149) who note that ‘Indonesia was the most affected economy in the Asian region’. During the crisis, Indonesia underwent the most severe economic contraction and was forced to engage the International Monetary Fund (IMF) for the longest period compared with other countries affected by the crisis as the IMF programmes were not terminated until 2003 (Martinez-Diaz 2006, p. 395). As a result of the crisis, the Indonesian rupiah depreciated approximately 80 per cent between July and November 1997. Nevertheless, the impact of the depreciation did not confer advantage in international markets because Indonesia’s major trading partners such as Japan also suffered from the financial crisis (Gautam et al. 2000, p. 44). Because of the recession, many corporations in the countries that were immensely affected such as Indonesia had little access to working capital and were weighed down by massive liabilities. In addition, short-term debt in Indonesia, Korea and Thailand exceeded available foreign exchange reserves (Radelet & Sachs 2000, p. 131), thus making these countries more vulnerable to financial panic. Company debt-to-equity ratios that were already high before the crisis increased, up to levels that could barely be deemed sustainable. Notably, Thailand’s ratio was 400 percent, Korea’s was 500 percent, and Indonesia had an even higher ratio (Corsetti, Pesenti & Roubini 1999, p. 69). Additionally, banks also came under extreme stress and several financial institutions effectively became bankrupt. Because of the high interest rates and the attempt to recapitalise financial intermediaries at a fast pace, the net worth of the bank system of Indonesia, Thailand and Korea deteriorated rapidly. Banks were forced to cut credit to firms (Corsetti, Pesenti & Roubini 1999, p. 69), implying that firms could not expand or obtain funds to support crucial projects. As Corsetti, Pesenti and Roubini (1999, p. 69) point out, contractions in trade credit were especially painful as such reductions undermine the firms’ capability to import the necessary inputs, and to produce and export domestic merchandise. Consequently, although Indonesia’s GDP grew by 4.5 per cent in 1997, there was a notable 13.2 per cent decline in GDP in 1998, and in 1999 there was only a marginal 0.9 per cent growth in the same (Krishnamurty 2009, p. 5). As a consequence of the dramatic economic contraction facing Indonesia, there was a major increase in unemployment rates perhaps due to the fact that the firms which could not cope with the financial strain were forced to lay off some of their workers. According to Krishnamurty (2009, p. 6), even in 2000, unemployment rates in Indonesia were still high compared to 1997. Although the unemployment rate was already rising even before the crisis, it increased sharply in 1998 to 5.5 per cent and further to 6.4 per cent in 1999. Hartono and Ehrmann (2001, p. 3) specify that 6.4 million workers were laid off in 1998. This unemployment was experienced in diverse sectors including construction, manufacturing, hotels, commerce, communication, finance, transportation, restaurants and many others. But along the same line, many economic sectors were able to accommodate more workers; these include agriculture, forestry, fisheries, animal husbandry, electricity and gas. For instance, many laid off workers were accommodated in the informal agricultural sector, which served as an employment safety net (Hartono & Ehrmann 2001, p. 3). How Indonesia confronted the 1997 financial crisis Indonesia’s initial response was to quickly widen the scope within which the rupiah traded, and when this proved futile, to initiate a float on 14 August 1997 (Lane et al. 1999, p. 4). When the rupiah continued to depreciate, the central bank implemented a very tight monetary stance. However, this policy had dire consequences for the already unstable banking sector (Haggard 2000, p. 65). The next step was for Indonesia to request the IMF for support as did the Philippines, Korea and Thailand (Hung & Weng 2010, p. 176). On 5 November 1997, the IMF approved a three-year standby arrangement with Indonesia worth $10 billion or 490 per cent of quota. Other financing agreements included $8 billion from the Asian Development Bank (ADB) and the World Bank. ADB also offered extensive technical assistance. In addition, there were pledges from interested countries totalling about $18 billion as a second line of defence. The aim of this intervention was to restore market confidence, introduce a systematic adjustment in the current account, reduce the inevitable decline in output growth, and control the inflationary effect of currency depreciation. Key interventions included tight monetary policy coupled with intervention in the exchange rate to stabilise the rupiah, policies to consolidate the underlying financial position to enable current account adjustment, a strategy to strengthen the financial sector, and a set of structural reforms to improve transparency and efficiency in the corporate sector (Lane et al. 1999, p. 4). Singapore’s experience Just like Indonesia, Singapore experienced a depreciation in its dollar – though the depreciation was a bit mild at 21 per cent (Development Analysis Network 2004, p. 139) compared with Indonesia’s 80 percent. The 1997 financial crisis also impacted various sectors unevenly. Areas such as transport, commerce, financial services and tourism, which have a significant regional exposure, were harshly afflicted (Siriwardana & Iddamalgoda 2003, p. 1). But overall, these impacts were not too harsh and Singapore was more resilient than Indonesia. According to Jin (2000, p. 5), Singapore’s exports to the other crisis-hit countries in Asia were badly affected because of the severely diminished regional demand, partly due to the collapse of these countries’ currencies. In addition, the apparent ‘appreciation’ of the Singapore dollar against the depreciated regional currencies eroded Singapore’s competitiveness. Consequently, the country’s economic growth declined from 8.4 percent in 1997 to 0.4 percent in 1998 (Chia 2001, p. 38). Further, banks in Singapore were weakened by their sizeable lending exposure to the countries that were hard hit by the crisis. Another point is that the large outflow of Singapore’s investment to the Asian region at the start of the 1990s suffered a severe slow down. On top of that, Singapore’s brokerage companies were hurt when the Kuala Lumpur Stock Exchange imposed new rules in August 1998 requiring all dealings in Malaysian shares to be done on the KLSE (Jin 2000, p. 5). How Singapore confronted the 1997 crisis The key to Singapore’s resilience to the 1997 financial crisis was effective use of exchange rate and wage instruments (Jin 2000, p. 1). According to Jin (2000, p. 1), Singapore’s managed exchange rate system enabled it to swiftly devalue the Singapore dollar in response to the loss of its competitiveness in exports due to the economic collapse of the other crisis-hit countries. As the crisis unfolded into 1998, Singapore decided not to adjust the nominal exchange rate but in its place worked towards direct measures to cut costs such as operating cost and wage reductions to remain competitive. Further, Singapore went on with financial reforms including liberalisation of the Singapore dollar to ensure its economy’s competiveness (Jin 2000, p. 1). Experiences of Indonesia and Singapore during the GFC and later The GFC, which emanated from the US due to a bubble economy that caused a rise in the property prices and subsequent failure of the mortgage market, caused a spill-over impact to other major economies such as Indonesia, but the impact was more pronounced on the advanced Asian economies such as Japan and Singapore (Adriyanto, 2010, p. 1). Indonesia’s experience On the fiscal side, the impacts of the GFC on the Indonesian economy appeared through various indicators, including the depreciation of the exchange rate and a decline in the stock market. By the end of 2008, the exchange rate of the rupiah had dropped by 30 per cent. Additionally, the Indonesia Stock Market Index witnessed a decline of 50 per cent in 2008. Further, growth of the banking credit experienced a significant decline, from 32 per cent to 10 per cent. Along this line, confidence among banks declined, as evidenced by the drop in interbank lending and borrowing, by 59.3 per cent from 206 trillion rupiahs in December 2007 to 83.8 trillion rupiahs in December 2008. Weak global economic growth also caused a reduction in the demand for Indonesian exports in the fourth quarter of 2008, and this resulted in weak demand for mining and primary exports, which made prices of mining goods and other commodities to plummet. This caused the rate of economic growth to slow down to 5.2 per cent year on year in the fourth quarter of 2009. Nevertheless, Indonesia’s overall economic growth was still 6.1 per cent, which was the third highest growth in Asia after China and India (Basri & Rahardja 2011, p. 217-218). Indonesia’s response to the GFC and later The Indonesian government responded swiftly to reduce the impact of the GFC and avoid future financial shocks. The measures implemented include (1) issuing a fiscal safety net regulation that clearly defines the roles, responsibilities, and processes that govern the actions and responses of the Bank of Indonesia, the Deposit Insurance Corporation and the minister of finance in case a given financial institution fails; (2) strengthening the role of the Bank of Indonesia as a lender of last resort; (3) increasing the deposit insurance scheme; and (4) easing the liquidity in the banking sector through financial expansion (Ginting & Aji 2012,p. 155). Singapore’s experience Singapore became the first ASEAN country to fall into the GFC. The country’s heavy reliance on trade in services and products increased the vulnerability of its open economy with regard to the recession (Embassy of Israel in Singapore 2009, p. 3). At the onset of the GFC, Singapore experienced a severe economic downturn, with its GDP declining by 9.5 per cent in the first quarter of 2009 and 3.3 per cent in the second quarter. Additionally, the country’s economy was severely affected by reduced international demand for manufacturing exports. Service sectors were also impacted by the sharp contraction in regional and global finance (ASEAN, Word Bank & Australian Government 2009, p. 1). According to estimates compiled by the Embassy of Israel in Singapore (2009, pp. 3-4), Singapore’s manufacturing sector is estimated to have condensed by 3.7 per cent by November 2008, down from an increase of 5.8 per cent in 2007. Singapore’s response to the GFC and later The government of Singapore has implemented a number of measures to contain the crisis and cushion the country from future shocks. The major focus has been to protect jobs by keeping people in jobs, assisting retrenched workers to find jobs, and retraining them with new skills. The government has also been engaged in two significant initiatives: the Skills Programme for Upgrading and Resilience (SPUR), which assists firms to pay for their workforce training; and enhancing government financing programmes for firms. With this second initiative, the government supports an additional $2.3 billion of loans to all local businesses. The government also announced a guarantee on deposits of individual and non-bank customers with banks, which lasted until December 2010 to increase confidence in the financial system. It also reduced spending on construction to ease pressure on building materials and construction resources (Embassy of Israel in Singapore 2009, pp. 5-6). Conclusion Indonesia and Singapore were exposed differently to the Asian financial crisis of 1997 and the 2008 GFC. While Indonesia was hard hit by the Asian crisis, Singapore was resilient because of its effective use of exchange rate and wage instruments. 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