INTRODUCTION

This chapter looks at two countries that were characterized by highly repressed interest rates and directed credit in the 1970s and 1980s. It illustrates common factors that drive financial repression and trigger liberalization, even in very different circumstances.

Indonesia and India differed, however, in their initial circumstance, the detail of their approaches to financial repression and liberalization and correspondingly, the outcomes. Indonesia, an oil exporter, emerged from hyperinflation in the 1960s and opened its capital account early, experiencing fairly rapid growth in the 1970s and 1980s. India, with less natural resources, has generally kept inflation below double digits, maintained more limited links to the international economy, and experienced rapid growth only in the 1980s. Indonesia maintained a small government budget deficit in the 1970s and 1980s and even achieved surpluses in the early 1990s, while India's Central Government deficit (consolidated public sector deficit) remains about 6 percent (10 percent) of GDP even after its stabilization of the early 1990s.

Both countries liberalized interest rate and credit allocations after they were hit by balance of payments problems. Indonesia freed rates in 1983, then, in 1988 moved to something like “free” banking, with little improvement in regulation and supervision. In contrast, India liberalized gradually and improved regulation and supervision significantly. Section 1 discusses Indonesia: the situation leading up to interest rate liberalization, the context and characteristics of liberalization, and the results of its approach to liberalization. Section 2 considers India's financial development in the same way. Finally, Section 3 summarizes the similarities and differences in the two countries' financial repression, liberalization, and response to liberalization.