Indonesian Economy: Contagion of World Financial Crisis and Policy Response

We focus on the impact of the sub-prime financial crisis contagion on Indonesia and the Indonesian government’s policy response. Indonesia was one of the worst affected emerging countries in the Asian crisis of 1997. Since then, the Indonesian economy has gone through a far-reaching adjustment process to overcome the legacy of that crisis.2 In spite of this, the recent sub-prime crisis contagion has seen a marked increase in financial market stress in Indonesia, leading to substantially decelerated export growth, and causing a significant slow-down in economic growth. We examine several factors which may have contributed to increased volatility in the dollar-rupiah exchange rate. These include the roles of foreign and domestic investors, the real exchange rate realignment and the dominance of commercial banks in financial markets. Results of an econometric study confirm that the foreign exchange rate volatility acquired the nature of a “long memory” after the Asian crisis. This inherited volatility may have amplified the impact of the sub-prime contagion. Indonesian authorities have responded quickly and decisively to the situation, adopting a series of financial measures since October 2008. In January 2009, the Indonesian President announced new fiscal stimulus measures and in February the Indonesian congress approved a supplementary budget to enact these measures