Introduction

During the 1980s, Indonesia undertook a series of structural reforms in response to its deteriorating economic situation especially in the market for Indonesia's primary export, petroleum products. It was recognized that high economic growth could not be sustained by export earnings alone, and that diversification from oil-related export was needed. The deregulation of the banking system removed control on interest rates and administratively determined credit ceilings were abolished. The devaluation of the rupiah and trade deregulation were part of the programme to stimulate economic growth and improve resource mobilization.

This chapter gives an overview of the Indonesian economy and discusses the process and effects of the financial liberalization. The reform in the financial sector should be examined in the context of the whole economic reform. Macro-economic and financial-sector indicators of 1981–88, which reflect the economic growth, capital accumulation, and financial deepening will be presented, as well as the behaviour of interest rates, and a brief review of the financial system in relation to the industrial policy. There is also an assessment on whether the dramatic switch in the regulatory regime generated any efficiency and growth benefits as predicted by financial repression literature (McKinnon 1973; Shaw 1973).

Macro-Economic Review and Economic Background to Deregulation

Since 1968 Indonesia has been having a high rate of growth, facilitated considerably by high oil prices in the 1970s and early 1980s. As an oil exporter, Indonesia experienced two major booms, in 1974–77 and 1979–82. The period of oil boom, which began with a quadrupling of oil prices in 1973 and continued with high prices until 1982, had profound effects on the Indonesian economy. Table 1.1 shows the growth of its gross domestic product (GDP) since the beginning of 1970. During the first period of the oil boom (1972–81), the average annual change was 8.1 per cent, a very high figure compared with other developing countries.