Assessing Vulnerability to Financial Crisis: Evidence from Indonesia

Abstract

This paper examines the view that the recent Indonesian crisis was largely unforeseen. The broadest macroeconomic indicators were of virtually no help in presaging the crisis; neither were high-frequency financial indicators. But warnings were there, just below the surface, in some of the macro indicators and in certain structural weaknesses that were long recognised as threats to financial stability. That said, none of these warnings suggested crisis of the magnitude that eventually occurred. The Indonesian experience indicates that macroeconomic stability should never be taken for granted. Signs of vulnerability to financial instability include: the degree of reliance on gross private capital inflows (taking into account maturities and the implications for rollovers); the extent of unhedged foreign exchange positions; and certain indirect indicators, such as policy slippages and key personnel changes. Finally, in a world of volatile capital flows, crisis will tend to occur before standard economic data suggest that crisis is imminent.

Unravelling financial market linkages during crises

“…These results are consistent with the analysis of the weakness of the Korean banking system and deteriorating fundamentals as laying the basis for its crisis (Puri et al, 2002). Analysis of the turmoil in Indonesian financial markets during the East Asian crisis generally highlights the role of political unrest, but disagrees on the extent of fundamental problems; Kenward (1999) argues that Indonesian fundamentals were sound, while Iriana and Sjöholm (2002) point to the role of the larger share of short-term debts as a weakness. Owing to this 112 M. DUNGEY AND V. L. MARTIN relative perceived fundamental strength, Radelet and Sachs (1998) and Goldstein et al (2000) have suggested that Indonesia was the country most affected by contagion in this crisis.…”

Correlation, Contagion, and Asian Evidence

“…Its' openness and export growth are only slightly higher than those of Indonesia, which is clearly the worst performing country in the sample on the basis of these indicators. Note that Kenward (1999) describes the lack of macroeconomic indicators of weakness in Indonesia prior to the crisis and Iriana and Sjöholm (2002) find less evidence of weakness than other economies in the region, but point to the role of the larger share of short term debts.…”

Indonesia's Economic Crisis: Contagion and Fundamentals

“…2 A number of previous studies suggested that the Indonesian crisis could not be explained by macroeconomic imbalances alone. See, for instance, McLeod (1997), Furman and Stiglitz (1998), Radelet and Sachs (1998), Kenward (1999), and Hill (2000). across countries and often manifests itself as a comovement of, for instance, exchange rates and stock prices.…”