Financial Fragility and Instability in Indonesia

Abstract

DOI: 10.1355/ae24-2i Financial Fragility and Instability in Indonesia. By Yasuyuki Matsumoto. Oxon: Routledge, 2007. Pp 258. With global conversation on financial stability taking flight around Basel II, Financial Fragility and Instability in Indonesia by veteran banker Yasuyuki Matsumoto offers an astute response to ongoing debate. This timely volume on causes of 1997 financial crisis in Indonesia recentres our attention from common macroeconomic focus on role of Central Bank to importance of microeconomic activities of capitalists and their institutions. As country most severely hit by financial crisis, Indonesia serves as an unambiguous expression of destructive effects of financial fragility and instability. Using four Indonesian conglomerates as case studies, Matsumoto argues that seeds of financial crisis were sown during years of rapid economic development from 1994 to 1997. Unsound financial structures, sharp increases in corporate leverage, reliance on external debt, and availing of riskier and more complicated financial instruments by Indonesian corporate empires rendered financial system profoundly unstable. Matsumoto's approach of examining microeconomic terrain of Indonesia's large conglomerates is a departure from conventional approaches that attribute root causes of financial crisis to shaky macroeconomic fundamentals. In explaining contagion of financial crises in Southeast Asia, many accounts ascribe financial meltdown to ineffective supervision and lax regulatory enforcement actions in banking sector. This study reveals that emphasis on role of domestic banks in precipitation of financial crisis in Indonesia is misplaced. Prior to 1997, domestic banks' access to offshore funds was under firm prudential control and their external debt levels were sustainable. In fact, this volume demonstrates that the rapid accumulation of external debt by Indonesian corporate during this period was more important than debt build-up in state and/ or banking sector (p. 44). To support his argument that microeconomic foundations of Indonesia's corporate directly contributed to financial crisis, Matsumoto presents an anatomy of Indonesia's debt from early 1990s and highlights heightened use of offshore loans for investment. The heavy reliance on offshore markets and foreign exchange debt left microeconomic financial structure in Indonesia fragile and unstable. It also placed limits on country's financial economy and left it vulnerable to external shocks. Grounding his main thrust in Hyman Minsky's hypothesis of financial instability, Matsumoto traces descent from risky cash flow positions and unmitigated offshore borrowing to crisis. Briefly, Minsky's financial instability hypothesis states that characteristics endogenous to a dynamic, capitalist economy, such as speculative finance and debt deflation, cause a financial system to evolve from being robust to being fragile. This volume modifies Minsky's financial instability hypothesis for an open and developing economy context. As causes of financial crisis, Matsumoto cites dominance of speculative financing units, problem of leverage, foreign exchange risk related to unhedged liability positions, piecemeal liberalization policies, and offshore banks' sudden and aggressive withdrawal of funds. Based on this assessment, Matsumoto examines three issues as contributors towards financial system instability and fragility, namely, financial positions of Indonesian private non-financial firms, offshore debt transactions of Indonesian debt borrowers, and financial activities of selected major Indonesian business groups. Delving into corporate finance, four in-depth case studies outline microeconomic foundations of financial crisis. Matsumoto selects Salim Group, Lippo Group, Sinar Mas Group, and Gajah Tunggal Group. …