I. Introduction
The evolution of financial liberalization or banking reform in Indonesia
is interesting in two aspects. The order of financial market reform,
which largely preceded real sector liberalization, was unusual in the
sense that the external capital account was opened prior to domestic
financial market reform. While the financial reforms of 1983 marked a
turning point in the history of Indonesian banking system, financial
reform in Indonesia has been neither a one-time change of policies nor,
as in Korea, a continuous smooth process of policy adjustment. Instead,
it has followed a pattern of two steps forward then on step back then
eventually several more forward steps, with the shifts in direction of
determined by some form of crisis.
The main purpose of this preliminary paper is to answer two main
questions involved in Indonesian banking reform in the 1980s and
1997/98. The main questions are two fold. Looking backward at the
banking reform in the 1980s, the first is under what conditions does the
government relinquishes its control over the allocation of credit in
favor of a more market-based system? The other is related to the
current Asian financial crisis spreading to Latin American and Russia.
What is the consequence of increasing globalization of capital mobility
in terms of the structural power of capital, foreign and domestic, and
its influence on the government’s economic policymaking in general and
banking policy in particular?
In explaining the process of banking reform in Indonesia, two conditions
are important: 1) the government’s availability of capital, foreign or
domestic, which allows the government to keep preferential credit
policies; 2) the change of power relationship among domestic groups
within the government who competing for control of finance in order to
either enhance or challenge existing patron-client networks. First,
increased availability of foreign capital provides the government with
opportunities to expand preferential credit schemes, whereas decreased
access to foreign capital makes it more difficult to do so and pushes
the government toward liberalization (Haggard and Maxfield 1993:314).
As in Korea, foreign capital obtained through international aids and
loans or exports has been the main source for the Indonesia government
to finance its economic policies through preferential credit system.
For Indonesian, oil/gas revenue is a single most import source of
government revenue. Thus, the availability of resources to the
Indonesian government’s is heavily influenced by the fluctuation of oil
price. An increase in the government’s access to foreign credit should
provide an opportunity to expand its role as a financial intermediary
between foreign and domestic financial markets, thus providing political
opportunities to extend benefits to supporters or favored activities.
The resurgence of the “interventionists” in Indonesia during the 1970s
can be explained by the fact that the oil boom and the influx of foreign
borrowing allowed the Indonesian government to sustain preferential
policies.
Second, economic crisis provides market-favoring domestic groups such as
economic technocrats and private bankers with opportunities to increase
their influence in the credit policymaking process, so that the
government is more likely to opt market-oriented credit policy. The
balance of payments crisis results in declining of the government’s
financial resource, strengthening the hand of “financial” ministries
within the government at the expense of the “spending” ministries
(Haggard and Maxfield 1993:296).
Finally, globalization of capital affects the structural power of
foreign and domestic capital and their influence over financial reform.
It will be argued that as capital mobility across borders increases,
foreign capital gains more structural power than domestic capital in
countries which do not have enough financial resource to implement
developmental economic policies. For capital-shortage countries,
foreign capital is an important resource in financing their favored
developmental economic strategies because success of their economic
policies increasingly depend on how much, how long, with what
conditions, and what type of capital they can get in the international
capital market. Under the era of globalization of capital, it is
important for capital-poor countries to create foreign capital-favored
economic policies and rules because international investors at any time
can get out of countries which seem inappropriate for investment from
their point of view. The failure to devise policies that meet the needs
of these investors can lead to less investment or even capital flight,
economic crisis, and eventually political instability (Winters 1996a).
This might be the underling force of the recent financial liberalization
in both Indonesian and Korea.
In the following section, I will briefly examine the Indonesian banking
system on the basis of factors such as its ownership and concentration
of market share (Henry 1988) and then quickly move to the analysis of
the banking reforms in 1980s. The final section will be devoted to the
recent Indonesian currency crisis which began in the mid-1997 and the
Indonesian government’s ongoing financial reform as response to it,
eliciting the argument that increasing globalization of capital mobility
will enhance the structural power of foreign capital.
II. The Indonesian Banking System
The Indonesian banking system can be characterized as a
state-dominated banking system in terms of its ownership and market
share. State banks accounted for 80 percent of total bank assets in the
end of March 1983 and 79 percent of all loans in 1983 (see table 1 & 2).
Table 1: Shares of total bank assets, by type of ownership, 1983-1994.
Ownership March 1983 December
1988 December 1994
Government* 80.2
71 47
Private domestic 11.2
24 44.3
Foreign and Joint venture 8.6
5 8.7
Note:
* Government banks include the state commercial banks,
Bapindo and the regional
development banks.
Source: Cole and Slade (1996: 22)
The Indonesian banking system, however, has experienced remarkable
transition from a government-owned and dominated system to an
increasingly privately-owned, market-oriented set of institutions since
1988 banking reforms. Between the end of March 1983 and December 1988,
as shown in table 1, the private domestic banks increased their share of
total bank assets from 11.2 percent to 24 percent, reflecting their
strong response to the removal of credit ceilings. State banks’ share
of total outstanding credit heavily decreased to 43 percent in 1994 from
93 percent in 1968 (see table 2). Herfindahl index of Indonesian
banking by credit has been relatively low, ranging around 5.4-4 percent
between 1993 and 1997 (see table 3). Thus, the current Indonesian
banking system is much closer to that of Turkey and Lebanon rather than
that of Egypt and Tunisia in terms of its ownership and concentration.
Table 2 : Distribution of Credit by Bank Ownership Category
(% of Total Outstanding Bank Credit)
Year Bank Indonesia State Banks Private National
Banks Foreign and Joint
Venture Banks
1968 49 44
6 1
1972 19 70
7 4
1973 15 70
6 9
1974 15 72
6 8
1980 31 55
7 5
1983 15 64
12 6
1988 4 65
24 4
1990 1 55
36 6
1992 1 56
35 8
1994 negligible 43
47 10
1995/96 - 39.4
48 10.5
1996/97 - 36.2
52 9.4
Note: For Bank Indonesia, only direct credits are included; liquidity
credits are excluded.
Credits from region (state) development banks are also
excluded, these are from 1 to 3 percent of
total credit.
Source: MacIntyre (1993), James (1996), Bank Indonesia, Report for the
Financial Year 1995/1996 and
1996/1997.
Table 3: Herfindahl Index of Indonesian Banking
Item 1993 1994 1995 1996
Assets 0.053 0.047 0.044 0.041
Deposit 0.051 0.046 0.046 0.040
Credit 0.054 0.047 0.042 0.040
Source: Bank Indonesia, Report for the Financial Year 1996/97
III. Banking Reforms in the 1980s
Until the bank reform of 1988, Suharto, the President of
Indonesia since 1966, had manipulated the Indonesian banking system by
controlling Bank Indonesia, the central bank of Indonesia, which was a
“rubble stamp.” There were four main mechanisms by which the banking
system and the allocation of credit were manipulated: credit ceilings,
interest rate controls, rediscounting, and direct central bank loans, so
called, “liquidity credits” (MacIntyre 1993:143).
Bank Indonesia first imposed domestic credit ceilings in 1974 as the
rate of inflation accelerated to more than 40 percent. Under the new
arrangement, Bank Indonesia determined a credit ceiling for each state,
private, and foreign bank on the basis of its performance during the
previous year. Credit ceilings were augmented by a system of detailed
government guidelines to the banks on the selective allocation of
credit. Banks were ordered to allocate a minimum proportion of their
credit quotas to pribumi (non-Chinese) businesses as well as to sectors
designated by the government. The five state commercial banks were each
further assigned a specific sectoral focus for their loans. In 1968
Bank Indonesia’s direct loans, together with those of the state
commercial banks, accounted for 93 percent of outstanding credit. Local
private banks were responsible for 6 percent of the total, and newly
returned foreign banks shared a mere 1 percent of the total. After 1983
private national banks continued to increase their market share up to 50
percent as of March 1997 (see table 2).
Most liquidity credits were allocated by state commercial banks as many
government priority lending programs were closed to private banks.
These nonmarket-based credit programs proliferated and spread into a
wider range of economic activities as well-connected businessmen and
lobbies sought to join in the rent seeking encouraged by access to
credit at artificially low interest rates (James 1996: 141). Thus,
state banks were able to make loans to state-owned firms and favored
private companies have close connections with politicians at
substantially lower interest rates than market rates.
As the oil boom of the 1970s and early 1980s ended abruptly, the
Indonesian government’s ability to sustain preferential credit policy
was seriously diminished by the balance of payments crisis caused by the
end of oil boom and rapid capital flight. In June 1983 the Indonesian
government announced removal of all bank credit ceilings, and also of
interest rate controls on the state banks. Previously, private banks
had not been subject to interest rate ceilings, but they had been
subject to credit ceilings, and this had limited their interest in
mobilizing deposits.
On October 27, 1988, the Indonesian government issued another major
package of banking reform measures, which were labeled “the PAKTO
reforms.” The 1988 reforms opened up the banking sector to new entrants
both foreign and domestic by allowing them to establish new banks and
new branches offices existing banks, both of which had previously been
highly restricted. They also reduced required reserve ratios from a
multiple set of rates that averaged about 11 percent to a uniform level
of 2 percent of all third-party liabilities (Cole and Slade 1996: 23).
Bank Indonesia sharply curtailed its interventions and participation in
the direct allocation of subsidized credit. As a result of the removal
of entrance barriers, between 1988 and 1991 the number of domestic
private banks more than doubled from 63 to 129 and the number of foreign
banks increased from 11 to 29 (see table 4).
Table 4: Numbers of banks by ownership category
Banks 1969 1982 1988 1991
1994 1995 1996 1977*
State commercial banks 7 7
7 7 7 7 7 7
Local government banks 23 27
27 27 27 27 27 27
Private national foreign 7 10
12 28 51 71 77 79
exchange banks
Private national non-foreign 123 60 51
101 111 90 88 83
exchange banks
Foreign and joint 11 11
11 29 40 41 41 41
venture banks
Total** 183 118
111 195 240 240 240 237
* February 1997
** Excluded Bank of Indonesia and rural savings banks
Source: James (1996: 140), Bank Indonesia, Report for the Financial Year
1995/1996 and 1996/1997.
Explanation of the banking reforms in 1980s is required to understand
the uniqueness of the policy-making process in Indonesia. Since Suharto
came to power in the late 1960s, there has been a striking trend toward
political centralization and exclusion, with effective control of the
policy-making process becoming increasingly concentrated in the hands of
a few state elites. At the center of the policymaking process, Suharto
plays a crucial role as “the final arbiter in accepting or rejecting”
the advice of various competing groups (Bresnan 1993:281). In times of
financial austerity, Suharto, as the final arbiter, usually accepted
more liberalized credit policy proposals by technocrats/economists. On
the contrary, when the government had plentiful resources to finance its
favored policies Suharto heavily took the advantage of the patron-client
relationship. Against a powerful and pervasive patron-client structure
extending from President Suharto downward, the government’s economic
ministers have sought to supplant patronage with markets and direct
forms of economic regulation with more indirect ones. The leverage of
the economic technocrats used to gain the power in the period of capital
shortage.
The balance of payments crisis in the early 1980s which was mainly
caused by an abrupt decline of oil price made it possible for
technocrats/economists to persuade Suharto to implement the banking
reforms. Sudden decrease of government revenue, confounded by the
collapse in the availability of external lending made him difficult to
reject the banking reform proposals put by market-oriented economic
technocrats. This is the reason why economic crisis was followed by
financial internationalization in many developing countries (Haggard and
Maxfield 1996). Furthermore, since the technocrats/economists have no
reliable power base that they can use to apply constant pressure within
the Indonesian state to win the policies they support, they take
advantage of economic crises by “extending, manipulating, and even
creating them so that their power is more enduring and the opportunities
form deeper and wider reforms are more lasting” (Winters 1996b: 2).
By the time of financial reforms of 1983, there was the “new view” about
selective credit programs in the developing countries which gradually
gained influence in the World Bank and other donor. The main idea of
this new view is that fiscally unsustainable subsidized credit schemes
could be profitably replaced with market-oriented credit programs. This
new view was apparently grasped by most Indonesian technocrats (James
1996: 147). There was also an important alteration in alliance building
within the state elite in the late 1980s. Whereas in 1983 the principal
institutional opponent of the economists/technocrats in the Ministry of
Finance had been the central bank, by the late 1980s, Bank Indonesia had
undergone a marked “cultural” transformation and a shift of policy
orientation from interventionist to market-oriented one, along with new
central bank governor Adrianus Mooy, who was the first governor to be
appointed from outside Bank Indonesia (MacIntyre 1993: 159).
IV. Financial Liberalization in 1977 and 1988
Indonesia is now experiencing unprecedented economic sufferings since
the economic crisis in the early 1997. The Indonesian economy has been
seriously hit by the recent Asian currency crisis starting from the July
1997 devaluation of the Thai baht, falling the Indonesian rupiah by 81
percent relative to its July 1997 level. The recent Indonesian
financial crisis is different from the crisis in the early 1980s in term
of several macroeconomic fundamentals. First, the current account
deficits, at 3.5 percent of GDP in 1996, were relatively low. Second,
the export growth in 1996 of 10.4 percent, while down from the 1995
level of 13 percent, was high enough to continue good economic
performance in the years to come. Third, the budget had been in surplus
by an average of over 1 percent of GDP for 4 years. Therefore, Radelet
and Sachs (1998) argue that although there were significant underlying
problems and weak fundamentals at both a macroeconomic and microeconomic
level, the imbalances were not enough to warrant the financial crisis of
the magnitude that took place in the second half of 1997. The key
source of the financial turmoil is unexpected sudden shifts in market
expectation and confidence—i.e., financial panic.
Continued falling of the value of rupiah due to the rapid withdrawal
of foreign capital, reducing its foreign reserves to almost default
level, was forced the Indonesian government to seek to aid from the
IMF. On October 31, 1997 the government signed its first IMF program,
which places primary emphasis on the restructuring and recapitalization
of financial institutions, with among other things such as strengthening
supervisory and regulatory regimes, reducing connected lending, and
tightening government spending.
After initial reform agreement with the IMF in return of a $23 billion
multilateral financial package involving the World Bank and Asian
Development Bank, the Indonesian government at first was reluctant to
follow the program. There are many examples. Bank Indonesia was
reluctant to shut down the insolvent banks. Suharto consistently tried
to implement a controversial currency-board system that would have
pegged the rupiah to the U.S. dollar in spite of strong oppositions from
the IMF, U.S. Germany, and Japan. Suharto replaced Soedradjad
Djiwandono, the Indonesian central bank governor who was understood to
oppose currency-board plan, with U.S. trained economist Sjahril Sabirin
who was supposed to support the plan. After being elected to his
seventh 5-year term, Suharto announced new cabinet, which includes his
daughter “Tutut” and several close business associates such as Mohammed
Hasan, who heads the Nusamba Group which controls huge timber
concessions. The reason why the Indonesian government was reluctant to
follow the IMF programs is that complying to the program would limit the
influence of the president’s family and close associates, who have
exploited their connections to build up powerful business empires in all
sector of the economy.
In spite of the government’s defiance against the programs, the
Indonesian government cannot help implementing financial reforms in
favor of market-based financial system. The elimination of restrictions
on foreign ownership of domestic banks. Following the closure of 16
small banks in early November 1997, seven small banks were closed and
seven others (including the second, fourth, and eighth largest private
banks) were placed under the Indonesian Bank Restructuring agency’s
(IBRA) control. In addition, state-owned Bank Negara Indonesia was
privatized last November and another state bank, Bank Rakyat Indonesia
is supposed to go to the public in 1999 (Financial Times, May 9, 1997).
The general trend of the reform is not quite deviant from the larger
schemes imposed by the IMF. This implies that increased globalization
of capital will enhance the structural power of international capital
relative to that of domestic capital. Under the circumstance of the
capital shortage, it is imperative for the countries of emerging markets
to attract substantial foreign private capital, which allows to finance
their developmental economic policies.
The underlying driving force of the 1983 banking reforms was the
immediate need to mobilize private savings more effectively in order to
replace the oil-funded system of subsidized credit. By revitalizing the
banking industry and making it more competitive, the Indonesian
government hoped that new sources of credit could be tapped and the
financial resources would be allocated on a more economically efficient
basis (MacIntyre 1993: 114-5). This basic aim of the 1983 reforms is
different from that of the recent ongoing financial reform in the sense
that the major aim of it is to create a more transparent and sound
financial system in order to bring mainly foreign capital back in.
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