Indonesian Experience with Financial Sector Reform

Since the early 1980s Indonesia has been engaged in serious efforts to reform the financial system, and thereby stimulate sounder economic growth. Discusses the nature of the specific reforms carried out in Indonesia, the environment in which they were undertaken and, most importantly, their effects on the real economy.

The paper finds that a fairly standard, phased series of reforms resulted in:

• Large, sustained increases in financial savings, increases in real savings, new financial products and more cost effective banks;
• Credit allocation suffering as state banks and new entrants made loans that became nonperforming;
• The unusual features of the reforms, opening the capital account before the financial sector, did not have adverse effects. Rather, the open capital account aided macroeconomic management by providing quick feed-back when domestic policies moved out of line and by limiting the inflationary consequences of excessive demand stimulus;

Indonesia's experience highlights the need for macroeconomic management that recognizes the limitations imposed by fiscal and external constraints and responds quickly to those constraints.