Mid-term Indonesian Economy PDF

A. BRIEF HISTORY OF INDONESIAN ECONOMIC POLICIES Indonesia's economic policies evolved significantly from the New Order era under General Soeharto (1966-1998) to the present. Soeharto's regime restored Western capital inflow, maintained political stability, and implemented six Five-Year Development Plans (Repelitas). Despite economic growth, structural weaknesses like corruption and weak governance led to the 1997-98 economic crisis, ending Soeharto's rule. His successors, B.J. Habibie, Abdurrahman Wahid, and Megawati Soekarnoputri, initiated political reforms and economic stabilization. Soesilo Bambang Yudhoyono, elected in 2004, prioritized pro-growth, pro-poor policies, and launched anti-corruption measures, followed by the RPJMN 2010-14, focusing on inclusive and equitable development. B. NEW GLOBAL ERA The 2008-09 global financial crisis had a profound impact on Indonesia, primarily through the reduction of global demand, declining exports, and a steep drop in commodity prices. As a country highly dependent on the export of raw materials and commodities like palm oil and rubber, Indonesia was particularly vulnerable to the global downturn. The weakening of the global economy led to a reduction in demand for these exports, which, in turn, put immense pressure on Indonesia’s economic growth. Additionally, the global recession caused significant disruptions in the financial markets, which affected Indonesia's currency and stock market. One of the most immediate effects of the crisis was the depreciation of the rupiah. The global flight to safe-haven currencies such as the U.S. dollar led to capital outflows from emerging markets, including Indonesia. As the rupiah depreciated, the country faced increased inflationary pressures, with the cost of imported goods rising significantly. This added to the strain on businesses, particularly those reliant on imports of raw materials or technology. Furthermore, the fall in the stock market during the crisis led to liquidity shortages, making it difficult for businesses to secure funding for operations. The crisis also highlighted Indonesia’s vulnerability to external economic shocks. As a developing economy integrated into global trade, Indonesia was not immune to the ripple effects of financial instability in major economies. The liquidity crisis in advanced economies led to a reduction in foreign direct investment (FDI) inflows into Indonesia, further exacerbating the economic slowdown. The reduced capital inflows not only affected businesses but also limited the government’s capacity to finance infrastructure projects, which were critical for stimulating economic growth. In response to these challenges, the Indonesian government introduced a range of monetary and fiscal measures aimed at stabilizing the economy. One of the key initiatives was a fiscal stimulus package designed to boost domestic demand. By increasing public spending on infrastructure projects, the government was able to create jobs and stimulate economic activity. This was complemented by social safety net programs, which provided financial support to low-income families and helped mitigate the impact of rising prices for essential goods. Monetary policy also played a crucial role in Indonesia’s response to the crisis. Bank Indonesia, the central bank, took decisive action by lowering interest rates to increase liquidity and stabilize the financial system. By cutting interest rates, Bank Indonesia aimed to make borrowing more affordable for businesses and individuals, thereby encouraging investment and consumption. In addition to lowering interest rates, the central bank intervened in the currency markets to stabilize the rupiah, helping to prevent further inflationary pressures. Despite these measures, Indonesia’s recovery from the crisis was not immediate. The global nature of the recession meant that Indonesia’s recovery was closely linked to the broader global economic environment. While the domestic stimulus packages helped to mitigate the worst effects of the crisis, Indonesia’s dependence on exports meant that a full recovery could only occur once global demand for commodities began to rise again. However, Indonesia’s strong domestic market, supported by government interventions, allowed the country to recover more quickly than many other emerging markets. In the long term, the 2008-09 global financial crisis served as a wake-up call for Indonesia, highlighting the need for a more resilient economic system. The crisis underscored the importance of diversifying the economy away from its reliance on commodities and strengthening its financial system to better withstand external shocks. The government’s response, including the promotion of infrastructure development and the enhancement of social safety nets, helped lay the groundwork for more sustainable and inclusive growth in the years that followed. C. DEMOCRATIZING INDONESIA Indonesia's democratization, which began after the fall of Soeharto in 1998, has significantly influenced its economic system. Moving from an authoritarian regime to a more democratic and decentralized system brought new opportunities for economic development. The introduction of democratic elections at all levels of government, combined with the independence of Bank Indonesia, helped to foster greater transparency and accountability in both political and economic decision-making processes. These changes were crucial in stabilizing the economy and attracting foreign investments, which had been undermined by corruption and lack of governance during the previous regime. The shift towards regional autonomy also played a key role in enhancing Indonesia's economic development. Local governments were given more authority to manage resources and make decisions that catered to the specific needs of their regions. This decentralization allowed for more tailored economic policies, improving infrastructure and local services, which in turn stimulated local economies. Additionally, the rise of civil society, labor unions, and the media further contributed to economic growth by advocating for workers' rights, fair wages, and social reforms, thus improving labor market conditions and reducing inequality. One of the most significant impacts of democratization on Indonesia's economy was the emergence of digital platforms that enabled greater public participation in political and economic discourse. Social media platforms like Facebook and blogs provided new avenues for activism, where ordinary citizens could express their views on government policies and corporate practices. This "people power" movement became particularly influential in cases like Prita Mulyasari's defamation trial, where public outcry helped shape legal and policy decisions. This digital activism has added a new layer of accountability for both government and private sector actors, fostering an environment conducive to fairer economic practices. However, the democratization process has also introduced challenges. The rise of "noisy" politics, where multiple voices and competing interests vie for influence, has made it harder for the government to implement cohesive economic policies. The controversy over the Bank Century bailout is an example of how political disagreements can complicate decision-making processes. While democratization has empowered citizens and allowed for a more open dialogue, it has also reduced the government's control over critical economic decisions, sometimes leading to delays or inefficiencies. Despite these challenges, Indonesia's growing prominence on the global stage has provided it with opportunities to shape international economic policies. Its inclusion in the G-20 group of major economies in 2009 signified Indonesia's emerging role in global economic governance. This recognition has allowed the country to contribute to global peace efforts and economic stability, while also benefiting from increased foreign trade and investments. This newfound global influence has helped Indonesia to strengthen its economic standing and pursue more ambitious development goals. In conclusion, democratization has brought both opportunities and challenges to Indonesia's economic system. While decentralization and the rise of civil society have contributed to more inclusive economic policies, the complexities of democratic governance have introduced new obstacles to policy implementation. Nevertheless, Indonesia's participation in global economic platforms like the G-20 showcases its growing role in the international arena, and the continued evolution of its democratic system holds the potential for further economic growth and development. D. MONETARY AND FISCAL POLICIES Monetary policy focuses on controlling the supply of money and managing inflation, while fiscal policy aims to correct market failures by promoting the production of goods and services. Indonesia's economic history has been shaped by various crises and political challenges, which have influenced its approach to these policies. Under the leadership of President Sukarno and later President Soeharto, Indonesia struggled with inflation, financial instability, and political interference in Bank Indonesia (BI), the nation's central bank. These challenges laid the groundwork for the country’s future monetary and fiscal responses to crises. Indonesia's experience during the 1997 Asian financial crisis was a turning point for its monetary policy. Financial liberalization during that period had led to an economic boom, but the absence of strong governance allowed speculative activities to flourish. The result was a severe economic collapse that highlighted the importance of monetary regulation. In response, Indonesia adopted a dual monetary system, incorporating both conventional and Islamic financial systems. This approach helped to minimize speculative activities, particularly in the banking sector, by offering an alternative that aligned with ethical financial practices, and it was instrumental in promoting greater stability in the years following the crisis. Fiscal policy, meanwhile, has played a crucial role in stabilizing the Indonesian economy during periods of financial crisis. During the 1997-98 Asian financial crisis and the 2009 global recession, Indonesia's government employed fiscal stimulus measures to support economic growth and recovery. These measures included increased public spending on infrastructure and social welfare programs aimed at protecting the urban poor, who were particularly vulnerable to the effects of the crises. By investing in these areas, the government not only stimulated the economy but also provided a safety net for the most affected populations. However, Indonesia's fiscal policies have faced significant challenges. One major issue is the country’s tax structure, which remains underdeveloped, leading to inefficiencies in revenue collection. Budget execution has also been a concern, as the process of disbursing funds for government projects and programs is often slow and prone to delays. Additionally, Indonesia remains vulnerable to external shocks, such as fluctuations in global commodity prices, which can undermine the effectiveness of its fiscal policies. These weaknesses limit the government’s ability to fully utilize fiscal policy as a tool for economic stabilization. In conclusion, both monetary and fiscal policies have been central to Indonesia’s efforts to manage economic crises. While monetary policy has evolved to incorporate dual systems and address speculative risks, fiscal policy has focused on stimulating growth and protecting the vulnerable. However, the effectiveness of these policies is constrained by structural weaknesses, particularly in the tax system and budget management. Moving forward, addressing these challenges will be critical to ensuring that Indonesia’s monetary and fiscal policies can continue to promote long-term economic stability and resilience. E. DOMESTIC MARKET A domestic market refers to the economic activity that occurs within a country's borders, including the buying and selling of goods and services by local consumers and businesses. In Indonesia, the domestic market is particularly significant due to the country's large population and diverse economic activities spread across its many islands. As the largest economy in ASEAN, Indonesia's domestic market offers immense potential for growth and development, attracting both local and international companies to invest in various sectors. The country's population dynamics, with a shift toward male dominance and increasing aging trends, also influence market demands, particularly in sectors such as healthcare, education, and consumer goods. Achieving a robust domestic market in Indonesia requires several key factors. First, there must be a stable economic environment with policies that encourage both local consumption and investment. This includes government initiatives to improve infrastructure, which is vital for connecting the different regions and enabling smooth trade within the country. Additionally, education and workforce development are crucial, as a skilled labor force is necessary for producing goods and services that meet the needs of the domestic market. Regions with higher education levels, often perform better in economic terms compared to less-educated regions, showing the importance of education in fostering economic growth. Moreover, fostering a flexible labor market is essential for ensuring the domestic market thrives. The Indonesian labor market has faced debates around how to balance the needs of businesses with the welfare of workers. Global market pressures often push for more flexibility in hiring and wages, favoring business interests, but this can lead to social unrest if workers feel their rights are being compromised. Ensuring fair labor practices while promoting economic flexibility is a delicate balance that can significantly impact the domestic market. If managed properly, a flexible yet fair labor market can stimulate domestic production and increase consumption. The strength of Indonesia's domestic market also has a direct impact on the overall economy. A well-functioning domestic market can act as a buffer during global financial downturns, as local consumption can help sustain economic activity even when international demand declines. For example, during the 2008-09 global financial crisis, Indonesia's large domestic market helped cushion the effects of falling exports and commodity prices. The government’s focus on stimulating domestic demand through fiscal stimulus packages and public spending on infrastructure projects was critical in maintaining economic stability during this period. The domestic market’s regional interdependence is a critical factor in Indonesia's economic landscape. West Java, as a central hub of trade, exemplifies how trade networks within the country are connected. However, disparities between Western and Eastern Indonesia highlight the challenges of regional inequality. A crisis in one region, such as Banten’s vulnerability due to its ties with Jakarta, can have a ripple effect across other areas, underscoring the need for balanced development. Strengthening the domestic market across all regions of Indonesia, not just the more developed western provinces, is essential for sustainable and inclusive economic growth. F. IN SEARCH OF NEW DEVELOPMENT PARADIGMS Indonesia's pursuit of new development paradigms is deeply influenced by its participation in regional and global economic platforms. One of the most significant initiatives is the ASEAN Economic Community (AEC), which seeks to create a single market with the free movement of goods, services, and skilled labor. While Indonesia stands to gain from this integration, the nation faces challenges, such as managing the potential impacts of currency unification and external economic shocks. These factors, if not properly managed, could have serious implications on Indonesia's economic stability. The ongoing debate around economic integration highlights the risks associated with short- term capital flows and the competition with China under the China-ASEAN Free Trade Agreement (CAFTA). Indonesia's manufacturing sector has been particularly affected by the influx of cheaper Chinese goods, which has caused difficulties for local producers. To mitigate these challenges, Kurniati and Budiman argue for strategic plans that both protect the local economy and ensure that Indonesia fully maximizes the benefits offered by the AEC. Indonesia's inclusion in the G-20 after the global financial crisis is a testament to its growing influence in the world economy. This shift in global governance, where the G-20 replaced the G-8, reflects Indonesia's rising role in shaping international economic policies. The country's improved governance since the 1997-98 Asian financial crisis has been crucial for maintaining stability and growth, yet further reforms are needed to strengthen transparency and public participation in economic development. A core aspect of the new development paradigm is the emphasis on people-centered growth. This approach prioritizes the welfare of citizens by focusing on reducing inequality, enhancing social safety nets, and promoting labor reforms. The Indonesian government is increasingly recognizing the need for sustainable development that includes environmental protection alongside economic growth, ensuring that future generations can benefit from the nation's resources without depleting them. In addition to addressing governance and environmental sustainability, there is also a strong call for reforms in the financial system. The 2008 global financial crisis exposed the vulnerabilities of financial institutions worldwide, including in Indonesia. Strengthening both macro (government reforms) and micro (corporate governance) frameworks is critical to preventing future financial crises and ensuring that Indonesia remains resilient in the face of external shocks. Overall, Indonesia's search for new development paradigms underscores the importance of balancing regional integration, global engagement, and domestic reforms. While the nation has made significant strides in improving governance and participating in international forums, the path ahead requires continuous adaptation to evolving economic landscapes, ensuring that growth is inclusive, sustainable, and resilient. CONCLUDING REMAKRS A new development paradigm in response to modern challenges, much like Keynes' revolution in the 1930s and Nitisastro's impact on Indonesia in the 1960s. It recommends prioritizing people-centered development, environmental sustainability, and good governance, emphasizing that economic growth should be seen as a means rather than the primary goal. Monetary policies and financial structures should shift away from speculative activities, with shariah finance proposed as a stable alternative. While recovery from recent crises is underway, there is concern about whether the poor are truly benefiting. Recommendations are made for the Indonesian government, with potential global relevance. A. CHAOTIC ECONOMIC DEVELOPMENT, 1945–1966 When Sukarno and Hatta declared Indonesian independence in 1945, people were hopeful for development that would improve their lives. Indonesia had a lot of natural resources, a favorable climate, and a large labor force, all of which gave the country potential for economic growth. During colonial times, the economy was focused on agriculture, especially plantations, with most products exported abroad to benefit the colonizers. This created an imbalance in Indonesia’s economy, with too much focus on agriculture for export. During the decades known as the Old Order era (1945–66), the economy was a servant to politics. The economy became a tool of politics, with little attention to rational economic policies. Resources, both domestic and foreign, were wasted, leading to a sharp economic decline. By 1966, Indonesia faced hyperinflation of over 600%, along with shortages in food, textiles, tools, and other essential items. Infrastructure like irrigation, plantations, factories, roads, electricity, and telecommunications were neglected. Food production couldn’t keep up with population growth, exports fell, and the country had to rely on increasing foreign loans to pay for imports. As the economy worsened, job opportunities shrank, with government service being one of the few growing fields. However, more government employees meant higher expenses, while revenues did not grow proportionally. As a result, the real income of civil servants dropped. Economic growth between 1961–1966 was very low (2.0%), even slightly lower than the population growth rate (2.1%), making income per capita stagnant. After the Old Order, there was a radical change in government policies during the New Order (led by President Suharto). The following sections will discuss policies during the Asian financial crisis (1997–1998) and the democratizing era (starting from 1998), including Bank Indonesia’s independence and ongoing economic growth. There will also be a look at strategies for economic recovery from 2009 to 2014. B. STABLE AND GROWING ECONOMIC DEVELOPMENT, 1966–98 The New Order era in Indonesia, led by General Soeharto from 1966 to 1998, brought about significant changes, both positive and negative, in the nation’s economic and political landscape. During this time, Soeharto’s authoritarian regime promoted strong political stability, a major role for the military, and the restoration of Western capital inflows. This era was marked by rapid industrial growth, increased exports, and economic expansion, particularly in sectors like steel, aluminum, cement, and oil. Indonesia’s economy shifted from being heavily dependent on primary exports, especially oil and gas, to manufacturing. This transformation was partly due to the oil boom of the 1970s, which provided the government with a large income that was invested in modernizing the economy. Indonesia’s economic growth during the New Order was impressive, averaging 7.0% annually from 1965 to 1997. This rapid growth led to the country's elevation from a low-income nation to lower middle-income status by the mid-1990s, with per capita income rising from $100 in 1970 to over $1,000 in 1997. Additionally, the success of family planning initiatives helped to slow population growth, contributing to the rising per capita income. The New Order implemented a balanced budget policy, which helped stabilize the economy in the late 1960s. The government also introduced a series of Five-Year Development Plans (Repelita), starting with Repelita I in 1969. The early Repelita plans focused on rebuilding agriculture, infrastructure, and transportation, while later plans emphasized industrialization, rice self-sufficiency, and export-oriented policies. Despite these successes, the era was also characterized by significant challenges. The rapid growth led to environmental degradation, particularly in deforestation for wood exports. Additionally, economic inequality increased as wealth and productive assets became concentrated among elites and Soeharto's close associates, leading to perceptions of cronyism and corruption. While poverty levels declined significantly from 40% in 1976 to 11% in 1996, rising inequality was a key issue. Social progress was also notable during the New Order. The government expanded primary education, and health outcomes improved, with declining infant mortality rates and better access to clean water. However, the education and health improvements were unevenly distributed, often favoring privileged groups. The era ended in 1998, following the Asian financial crisis, which exposed the underlying vulnerabilities in Indonesia’s economy, leading to political unrest and eventually the fall of Soeharto’s regime. C. TOTAL CRISIS, 1997–98 In the late 1980s, Indonesia's rapid economic growth was helped by deregulation, but problems began to surface. Issues like corruption, collusion, and nepotism (KKN) weakened the government’s legitimacy. Economic inequality between rich and poor, and between indigenous and non-indigenous groups (especially Sino-Indonesians), increased. This threatened social stability. By the 1990s, concerns grew over government financial discipline, as money was spent on controversial projects not controlled by the finance minister. Corruption and oppression among the New Order elites led to political instability. In 1997, the Asian Financial Crisis hit Indonesia, starting with a currency depreciation. The rupiah fell from Rp 2,300/USD to Rp 15,000/USD by mid-1998, and the stock market crashed due to massive capital outflow. Indonesia's economy, which had been growing for three decades, went into a deep crisis due to weak economic management, poor corporate governance, and a fragile banking system. GDP dropped from 8.0% in 1996 to 4.7% in 1997, unemployment rose from 4.9% to 7.5%, and inflation skyrocketed from 5.17% to 34.22%. Interest rates shot up to 60-70%. In October 1997, Indonesia sought help from the IMF. However, political uncertainty and doubts about the government's commitment led to continued depreciation of the rupiah and rising inflation. 1998 saw worsening economic conditions: absolute poverty increased, the El Nino drought damaged crops, oil prices fell, and the economy contracted by 13.1%. In May 1998, after 32 years in power, President Soeharto resigned amidst massive protests. In 1999, Indonesia began to stabilize with better monetary conditions, improved political climate, and returning investor confidence. Inflation decreased, the rupiah strengthened, and interest rates dropped. The economy recovered more slowly than other Asian countries in crisis, but structural changes occurred, like a shift from agriculture to manufacturing and services, and greater trade participation. D. DEMOCRATIZING ERA, 1999 ONWARD: Independence of Bank Indonesia In response to the economic crisis, the Indonesian government realized that macroeconomic policies alone were insufficient and began to adopt microeconomic measures as well. They included reforms in the banking system, corporate debt resolution, and access to international financial markets. Institutional reforms were also a priority, especially in improving the legal system. A significant development was the introduction of the Central Bank Act of 1999, which made Bank Indonesia independent. Key Microeconomic Measures by Banking and business sector rehabilitation, focusing on corporate debt and regaining international financial access and Improvements to regulations and laws related to the monetary, banking, and real sectors. Central Bank Independence (Act No. 23/1999): Goal independence: Bank Indonesia could set its own short-term targets. Instrument independence: It had the freedom to decide interest rates and monetary policies without government intervention. Personal independence: Bank Indonesia could not be forced to follow orders from any external organization, including the government. Compared with the Past, before 1999, Bank Indonesia had much less independence, governed by Act No. 13/1968. The independence score increased from 0.45 to 0.87 (on a scale of 0 to 1) after the 1999 Act. Historical reference to England's banking system: In 1797, the government made the pound sterling non-convertible to gold for its benefit, but it returned to gold convertibility in 1821 to reduce government control over the market. E. SLOWLY, YET CONTINUOUSLY GROWING ECONOMIES June 1999: Indonesia held its first democratic presidential election in 44 years. Abdurrahman Wahid became president, with Megawati Soekarnoputri as vice president. 1999: Wahid’s administration reversed many restrictions from the Soeharto era, such as freeing political prisoners and increasing press freedom. Indonesia’s economy grew by 0.3%, a significant recovery from -13% in 1998. 2000: The economy continued to recover with 4.8% GDP growth, a stronger banking system, and efforts to resolve government debt issues. However, corporate debt restructuring and other challenges slowed the recovery. The rupiah depreciated due to internal and external pressures. July 2001: Wahid was impeached and replaced by Megawati. Her administration made progress in stabilizing the economy and worked with the IMF to implement reforms. 2001: Economic growth was 3.3%, but unemployment rose to 8.1%. The rupiah depreciated significantly, and inflation rose to 12.55%. 2002: The economy grew by 3.7%, with inflation decreasing to 10.03%. Improvements in the exchange rate, inflation, and interest rates helped the recovery. 2003: The economy performed well, with lower inflation, stronger banks, and a stable rupiah. GDP per capita returned to pre-financial crisis levels. However, structural problems remained. 2004: Economic growth reached 5.1%, supported by strong domestic demand, investment, and exports. Although inflation rose to 6.4%, it remained within target. The year marked Indonesia’s exit from the IMF stabilization program and a stronger focus on democracy through direct elections. The government implemented short-term programs to maintain macroeconomic stability. F. CONTINUOUSLY HIGHER ECONOMIC GROWTH 2004 Megawati’s administration introduced direct presidential elections, and Susilo Bambang Yudhoyono (SBY) became Indonesia’s first directly elected president. After taking office, SBY launched a “pro-growth, pro-poor, pro-employment” economic program. He aimed for 6.6% annual growth and created a 100-Day Agenda to energize the bureaucracy. In December, SBY announced an ambitious anti-corruption plan. In 2005, SBY’s administration focused on creating a safe, just, and prosperous Indonesia, with a stable macroeconomic framework. Despite economic challenges like excess liquidity, inconsistent policies, and rising global oil prices, Indonesia achieved a 5.6% growth rate. Bank Indonesia took steps to stabilize the rupiah and inflation, which soared to 17.1% after fuel price hikes.In 2006, Inflation eased to 6.6%, allowing for steady economic growth at 5.5%, driven by consumption and exports. However, investment growth slowed, meaning economic progress did not fully reduce poverty or boost employment. In 2007, The economy grew at over 6% for the first time since the 1997–98 crisis, thanks to strong policies and favorable global conditions. Indonesia had a surplus in its balance of payments, stabilized the exchange rate, and managed credit and inflation well. Open unemployment fell from 11.1 million in 2006 to 10.5 million, and poverty rates improved from 17.8% to 16.6%. These gains also contributed to achieving the Millennium Development Goals, particularly in poverty reduction, child mortality, and education. In the era of 2008-2009 The global crisis slowed growth to 4.5%, but Indonesia’s economy was still one of the best-performing globally, only behind China and India. Despite slower growth, the poverty rate fell to 14.1% by 2009. Indonesia maintained political stability, low inflation, a steady rupiah, and a reduced government debt-to-GDP ratio (28% in 2009). Foreign exchange reserves reached $71.8 billion by March 2010. G. GLOBAL RECESSION In 2008 (First Half), Indonesia’s economic growth reached 6.1%, driven largely by strong export growth in mining and agricultural commodities. Exports surged due to rising global prices and strong demand from China and India. This export growth boosted purchasing power, especially in export-producing regions, increasing consumption and investment. Import growth also increased due to the demand for raw materials and capital goods. In 2008 (Second Half): Global economic conditions worsened, leading to a decline in export growth, as global commodity prices fell. Growth in household consumption, investment, and imports also slowed. Global financial markets became volatile, creating uncertainty and reducing investor confidence. This caused capital outflows from emerging markets, including Indonesia. Balance of payments recorded a deficit of US$2.2 billion, and by the end of 2008, foreign reserves stood at US$51.6 billion (equivalent to 4 months of imports and debt servicing). The subprime mortgage crisis in the U.S. caused massive global impacts, leading to a downturn in Indonesia’s exports. Rupiah and Inflation, The rupiah experienced strong downward pressure and volatility, depreciating to Rp. 12,150 to the U.S. dollar by November 2008. The average annual depreciation of the rupiah was 5.4% (from Rp. 9,140 in 2007 to Rp. 9,666 in 2008). Inflation reached 11.06% due to rising global oil prices and a 28.7% fuel price hike in May 2008. Supply shortages of kerosene and bottled LPG worsened the situation, while rising world food prices increased food’s contribution to inflation. In short, Indonesia's economy grew well in early 2008 but faced significant challenges later in the year due to the global financial crisis, impacting exports, the rupiah, and inflation. H. STRATEGIES IN 2009–14 : Ten Steps to Economic Stabilization In late October 2008, the Indonesian government introduced a ten-step policy to stabilize the economy and mitigate the impact of the global financial crisis. The goals were to keep economic activity steady, sustain recovery, and address challenges faced by economic agents. The key steps included: Step 1: To support the balance of payments, state-owned enterprises were required to deposit their foreign currencies in domestic banks and report their foreign exchange activities. Step 2: Expedite infrastructure projects with financing commitments from bilateral and multilateral sources. Step 3: Ensure liquidity stability by prohibiting state-owned enterprises from transferring funds between banks to prevent price wars. Step 4: Maintain confidence in government bonds through gradual and measured purchases by the government and Bank Indonesia in the secondary market. Step 5: Utilize bilateral swap arrangements with the Bank of Japan, Bank of Korea, and Bank of China, when needed, to support the balance of payments. Step 6: Provide a guarantee for exports to reduce payment risk and encourage exporters to sell their drafts at a discounted rate. Step 7: Revoke the CPO (Crude Palm Oil) export duty to ensure economic sustainability starting in November 2008. Step 8: Ensure the sustainability of the 2009 State Budget. Step 9: Prevent illegal imports by restricting the import of certain commodities (e.g., garments, electronics, food) to registered importers, with verification at designated ports. Step 10: Establish an integrated taskforce to improve the monitoring of goods circulation, starting in November 2008. In essence, these measures were designed to stabilize Indonesia’s economy by supporting key sectors like exports, infrastructure, and government bonds, while also controlling imports and foreign exchange flows. I. Election Year 2009 Early 2009: Indonesia faced challenges from the global crisis, causing instability in the monetary and financial systems. Economic growth was on a downward trend due to a contraction in exports and services, which reduced confidence in the economy. Response to the Crisis, Bank Indonesia and the government implemented monetary and fiscal stimulus policies to maintain macroeconomic stability and prevent further decline. These were a continuation of measures taken in late 2008, helping to stabilize the economy by the second quarter of 2009. Economic Performance in 2009, Indonesia's economy showed resilience despite global contraction, largely due to domestic demand. Financial markets and macroeconomic stability improved by the end of 2009, reflected in key indicators like Currency Default Swap (CDS), Composite Stock Price Index (CSPI), and exchange rate. Inflation dropped to 2.78%, the lowest in the last decade. Presidential Election 2009: Yudhoyono was re-elected with a vision for the 2009– 2014 period focused on being pro-growth, pro-employment, and pro-poor. Economic Vision (2009–2014): High economic growth needed to be accompanied by equity and justice, with a focus on real sector growth. Key sectors for growth included agriculture, industrial services, tourism, and the creative economy. Policies aimed to provide tax incentives and stimulus to boost business, while ensuring infrastructure development, energy, food security, SMEs, and transportation were not neglected. A focus on new investment to reduce unemployment and poverty. Collaboration with local governments was emphasized for successful implementation. The goal was to create a business-friendly environment for entrepreneurs and investors, while ensuring fairness in society. This approach helped Indonesia to weather the global financial crisis while maintaining economic stability and supporting long-term growth. J. National Medium-term Development Plan (RPJMN) 2010–14 National Long Term Development Plan (RPJPN) 2005–25, the process of achieving the national vision and mission will be implemented through five-year stages. (RPJMN) 2010–14, which is the second stage, prioritized the improvement of the quality of human resources, including the development of science and technology capabilities, and strengthening economic competitiveness. This document has been set by the government through Presidential Decree no. 5/2010. The 2010–14 RPJMN is arranged in three books. Book I (first) contains the vision, mission, objectives, macroeconomic framework, and national priorities. Book II (second) elaborates on the development strategies for nine development and cross-sector issues. The nine areas are: Socio-Cultural and Religious Life; Economy; Science and Technology; Facilities and Infrastructure; Politics, Defence and Security; Law and Apparatus; Regional and Spatial Planning; and Natural Resources and Environment. Book III (third) contains strategic issues and regional development strategies with the discussion organized for seven archipelagos: Sumatera, Java-Bali, Kalimantan, Sulawesi, Nusa Tenggara, Maluku, and Papua. RPJMN 2010–14 focuses on two approaches. The first approach concentrates on national priorities. The RPJMN mentioned the implementation of eleven national priorities , The second approach is the implementation of business planning. The National Medium- term Development Plan (RPJMN) 2010–14 follows what the government called the “Development for All”. In his testimony to the Indonesian people on 11 December 2009, President Susilo B. Yudhoyono mentioned six basic policies in development strategies. In a retreat in Tampak Siring, Bali, Indonesia from 19–21 April 2010, attended by cabinet members, governors, provincial legislative councils, and business communities, President Yudhoyono announced an economic road map, the first target is to achieve an annual economic growth rate of 7.0 per cent. The second is to reach a per capita income of US$4,500 by 2014. The third target is to reduce the unemployment rate to between 5.0 and 6.0 per cent by 2014. And the fourth target is to bring the poverty rate down to between 8.0 and 10.0 per cent by 2014. The “new” feature is the emphasis on the spirit of “justice for all” in the president’s economic programmes. To achieve those targets, Indonesia is facing both challenges and opportunities. The development of the world economy shows the growing role of Asia in the global economic arena as the role of China and India is getting stronger. At the same time, the role of Indonesia in the world economy is also increasing as it has been considered a member of the G-20. CONCLUDING REMARKS 1960s (Sukarno era) Indonesia faced hyperinflation and economic decline. New Order (Soeharto era) For three decades, Indonesia experienced rapid economic growth and became one of Southeast Asia’s newly industrialized economies, similar to the Asian Tigers (Hong Kong, Singapore, South Korea, Taiwan). 1997/98 Financial Crisis Indonesia's economy contracted, leading to political reforms In SBY era, Pro-Growth, Pro-Employment, Pro-Poor. The strategy, called Development for All, aims for inclusive and equitable growth that benefits everyone, not just economic growth alone. With focus area Pro-people programs, focus on social protection, community empowerment, and economic improvement for the poor. Justice-oriented programs focus on marginalized groups like neglected children, the elderly, drug victims, remote communities, and migrant workers. Millennium Development Goals (MDGs), These targets include poverty eradication, universal education, gender equality, reducing child mortality, improving maternal health, controlling diseases, ensuring environmental sustainability, and global partnerships. Not just international commitments, The MDGs aim to provide real benefits to the people, improving lives at national, provincial, and district levels. REFERENCE Ananta, A., Soekarni, M., & Arifin, S. (Eds.). (2011). The Indonesian economy: Entering a new era. Institute of Southeast Asian Studies. A. MONETARY POLICY IN THE PRE-CRISIS ERA 1. The Early Years of Bank Indonesia (1953–1968) Bank Indonesia was established in July 1953 under the Undang-Undang Pokok Bank Indonesia Act, no. 11/1953, replacing De Javasche Bank, the central bank in the colonial era. The bank's goals were to maintain the stability of the rupiah; to issue and circulate paper currency and ensure smooth domestic and international payment systems; to regulate and develop a sound bank and credit; and finally, to supervise bank and credit. The Monetary Board, chaired by the minister for finance, held both monetary and fiscal authority and the minister for economy and governor of Bank Indonesia as members. During Indonesia's first twenty years of independence (1945-1965), this early period witnessed economic turmoil, structural weaknesses, low growth, low income per capita, a high rate of unemployment concurrent with the high rate of population growth, and the growth of the foreign exchange black market has made the situation worse. Budget deficits soared due to high government expenditures to finance military expenses and “beacon” projects, which were not supported by sufficient revenues. To finance the deficits, Bank Indonesia extended support in the form of an advance to the government. Consequently, at the end of 1966, the money supply increased by up to 1,000%, which triggered hyperinflation of 635%. Subsequently, the people’s propensity to save (and therefore also bank deposits) decreased drastically. Banks could only depend on the central bank’s fund to extend loans, which in turn worsened the excess money supply and accelerated hyperinflation. Bank Indonesia implemented various monetary policies as part of the government's rehabilitation and stabilization programs that are shown in Table 3.2. 2. The Second Era of Bank Indonesia (1968–1983) To further support the rehabilitation and stabilization, and in line with Banking Act No. 14/1967, a new Central Bank Act No. 13/1968 was stipulated to support the government’s development programs. The aim was to maintain the stability of the rupiah, promote economic growth, and improve employment. Monetary authority was still in the hands of the Monetary Board, which means Bank Indonesia was still part of the government and was involved in the first development program, the PELITA (Pembangunan Lima Tahun—Five-Year Development), which began in 1969. During this period, economic conditions improved, with inflation dropping to 9.9% in 1969, time deposits increasing from Rp. 4.5 billion in 1968 to Rp. 33.6 billion in 1969, and fiscal and monetary policies being well coordinated. However, the government lacked attention to prudent policies, still ran budget deficits, and foreign investors were still reluctant to invest in Indonesia. To support the development plan, monetary policies focused on price stability to control inflation, encourage savings by introducing a national development saving deposit (Tabungan Pembangunan Nasional or TABANAS) and a periodic insurance deposit (Tabungan Asuransi Berjangka or TASKA), and promote domestic investment by introducing “investment loan facilities” to domestic investors at low interest rates. Bank Indonesia managed inflation by controlling the money supply and shifting the sources of money supply from inflationary sources to non-inflationary sources to achieve price stability. Moreover, in the fiscal sector, the government changed its budget deficit policy to a balanced budget policy and stopped printing money to finance the budget deficit. Furthermore, to provide a sound business climate in the external sector, the government implemented free capital movement and a fixed exchange rate, where US$1 was fixed to Rp. 378 in December 1970, and Rp. 415 in February 1973. However, the international monetary crisis in 1971 led to inflation jacked up again to 25.8% in 1972 and 27.3% in 1973 because of the breakdown of the Bretton Woods Agreement. The new Banking Act and Central Bank Act improved the role of the banking system in the economy, led to significant savings, and bank credit increased dramatically. The early second PELITA (1974-1978) was characterized by a prolonged monetary crisis, beginning with the US unilaterally ending the convertibility of the U.S. dollar to gold. The Bretton Woods Agreements from 1950 to 1972 established the U.S. dollar as the world currency pegged to gold, ensuring its exchangeability with gold at any time. This period was known as the golden age, where personal income, world trade, and investment increased while maintaining international economic stability. In 1974, Indonesia experienced inflation of 33.3% due to crude oil price hikes, short-term capital inflows, and credit expansion from Bank Indonesia. To address this, the government launched a stabilization program, implementing tight money policy, raising interest rates, reserve requirements, and imposing a credit ceiling. It also introduced small-scale investment and permanent working capital credit (Kredit Investasi Kecil or KIK), along with permanent working capital credit (Kredit Modal Kerja Permanen or KMKP) for less fortunate groups. This led to a gradual decline in inflation from 14.2% in 1976 to 6.7% in 1978, with high interest rate policies increasing bank savings. In the early third PELITA (1979-1983), Indonesia's economic conditions were impacted by a world recession and high oil prices. The rupiah was overvalued, leading to uncompetitive commodity prices and higher inflation than trading partners. In November 1978, the rupiah was devalued to Rp. 625/US$1, and a managed floating regime was implemented. High oil prices led to high government revenues, Current Account Surplus, and excessive money supply. Bank Indonesia implemented a tight money policy in 1979/1980 to clear excess money supply. In 1982, oil prices decreased government revenue from oil exports, resulting in the worst Current Account deficit and lowest growth at 2.2%. To boost non-oil and non-gas exports, Bank Indonesia provided export credit facilities, leading to increased economic growth to 4.2% in 1983. However, inflation also increased to 11.5%. The monetary policy in the second era of Bank Indonesia (1968-1983) was prioritized to support the government's long-term development plan. Despite the international monetary crisis and the world recession, the development plan successfully maintained a relatively high economic growth rate of 7.24% a year. 3. Post-Financial Liberalization (1983–1997) The 1980s saw a global recession, an oil price drop, protectionism, and decreased non-oil commodity prices. Indonesia's economy slowed down due to structural weaknesses. The government implemented financial liberalization, dividing it into two stages: financial deregulation in June 1983, and monetary and banking deregulation in October 1988 and March 1989. The initial policy in March 1983 was to devalue the rupiah from Rp. 702.5/US$1 to Rp. 970/US$1. In June 1983, the banking system underwent a first-stage deregulation to improve its role in the financial system and encourage people to be bank-minded. The deregulation aimed to eliminate the credit ceiling, allow government-owned banks to set their own credit and deposit policies, and phase out Bank Indonesia liquidity credit. This deregulation aimed to minimize market distortion, improve fund allocation efficiency, and prevent capital outflow. In the monetary sector, direct monetary policies were replaced by indirect monetary policies, including reserve requirements, open market operations (OMO), discount facilities, and moral suasion. This means that Bank Indonesia could control base money (M0) indirectly to affect broad money supply (M1 and M2), so that inflation could be controlled. For this purpose, two monetary instruments were introduced: the Bank Indonesia Certificate (Sertifikat Bank Indonesia or SBI) and the Money Market Securities (Surat Berharga Pasar Uang or SBPU). The results were promising, with significant increases in fund mobilization and bank customer numbers. The money supply increased from Rp. 2.1 trillion in 1982/1983 to Rp. 7.2 trillion in 1987/1988, with inflation controlled at an average of 7.25%, economic growth at 5.1%, and low unemployment at an average of 2.3%. The second stage of financial, monetary, and banking deregulation in October 1988, known as PAKTO'88, was a continuation and refinement of the first-stage liberalization. The second stage, known as Sumarlin Move I, aimed to strengthen inflation control, accelerate economic growth, and expand employment through fund mobilization, acceleration of non-oil and non-gas exports, enhancement of bank efficiency, and development of the equity market. The PAKTO'88 deregulation package included allowing new banks and branches, encouraging participation in fund mobilization through TABANAS and TASKA saving schemes, lowering reserve requirements from 15% to 2%, simplifying corporate go-public requirements, and establishing a parallel bourse. The policy also refined the swap mechanism and introduced a stronger financial and banking sector. However, the deregulations led to increased interest rates and speculative activities in the money market. In response, Bank Indonesia implemented a tight monetary policy stance in April 1990, raising the SBI rate in February 1991 in the so-called Sumarlin Move II. In 1993, Bank Indonesia shifted to a tight monetary policy, raising the SBI rate to counter capital outflows. Investment grew robustly from 1995 to 1996, attracting capital inflows and causing the rupiah to appreciate. Reserve requirements were raised to contain the expansion, but the situation remained unchanged until the 1997 financial crisis. Overall, between 1983-1997 monetary policy prioritized financial and banking system development for economic development and improved management. Inflation was controlled at 8.1%, economic growth at 6.4%, and unemployment at 3.2%. B. MONETARY POLICY IN THE PASCA-CRISIS ERA 1. During the Crisis (1997–1999) Southeast Asia faced a financial crisis in 1997, triggered by external systemic events such as the Asian Tiger countries' overheating economies, political instability, and currency devaluation. Indonesia's structural weaknesses were masked by high economic growth from 1988 to 1997. Foreign investors withdrew assets, leading to a sudden increase in foreign exchange demand and a significant depreciation of the rupiah. Bank Indonesia responded by widening the intervention band, but the foreign exchange reserve was drained rapidly, leading to a free floating exchange rate regime. The Indonesian government sought IMF assistance in the form of a Standby Arrangement (SBA) amounting to $10 billion to restore market confidence and address financial sector weaknesses. Bank Indonesia faced a financial crisis in 1997, leading to an increase in inflation and economic contraction. The government raised SBI's rate, causing non-performing loans (NPLs) to spread and deteriorate return on assets (ROA) and capital adequacy ratio (CAR). The crisis also triggered political and social unrest, forcing President Soeharto to resign. To restructure the banking system, the government issued debt instruments and issued new Bank Indonesia Acts. The crisis led to a drop in inflation to 1.92% and economic growth to 0.3% in 1999. However, Indonesia and Thailand suffered the most, with fiscal costs reaching 56.8% of GDP and output loss reaching 67.9%. It wasn't until 2004 that Indonesia's economy grew above 5.0% again. 2. Post-Southeast Asian Financial Crisis (2000–2004) Bank Indonesia became an independent central bank. As a result, a new Central Bank Act No. 23/1999 entered into force in 1999, focusing on achieving and maintaining rupiah stability. Its primary tasks include setting and implementing monetary policy, regulating banks, and maintaining a sound payment system. Since its independence, Bank Indonesia has had three primary tasks that are to set and implement monetary policy, to regulate and administer banks, and to regulate and maintain a sound and effective payment system. Act No. 24/1999 reaffirmed the maintenance of the free foreign exchange rate system that had been in place since 1998, and the floating exchange rate system in place since August 1997 that allowed Bank Indonesia to intervene in the foreign exchange market. Monetary policy shifted from a quantity targeting framework to a price targeting framework, which directly targets the inflation rate, a shift from soft or mild inflation targeting. In early 2000, Indonesia experienced economic restructuring and recovery, but inflation and exchange rates remained a significant issue. Inflation rose to 9.35% in 2000, and unemployment reached 6.08%. Monetary policy focused on controlling excess money supply, with the banking system's intermediation function not improving. By 2004, inflation was controlled at 6.4%, economic growth increased to 5.1%, interest rates were lowered to 7.43%, and unemployment remained high at 9.86%. 3. Under an Inflation Targeting Framework (2005–present) The Bank Indonesia Act of 1999 was amended in 2004 to refine monetary management effectiveness. In 2005, Bank Indonesia implemented a full-fledged ITF to influence money market rates and deposit and lending rates in the banking system. ITF is characterized by an inflation target, anticipative monetary policy, constrained discretion, and compliance with good governance principles. The ITF framework is based on sound monetary policy principles, Act No. 23/1999 mandate, and success stories of countries curbing inflation without increasing output volatility. Inflation is crucial for sustainable growth, as it correlates with fluctuations and can lead to higher long-term interest rates, making business planning difficult and investors losing interest. Monetary authorities argue that an anti-inflation policy is a pro-growth policy. Monetary instruments used include open market operations (OMO), standing facilities, intervention on the foreign exchange market, minimum statutory reserve requirement, and moral suasion. In 2005, external factors and global imbalances pressured the domestic economy, leading to accelerated inflation and a tight monetary policy. Bank Indonesia responded by raising the BI rate, raising statutory reserve requirements, and intervening in the foreign exchange market. In 2006 and 2007, inflation was controlled, and the BI rate was gradually lowered to 8.0%. In 2008, Bank Indonesia replaced the operational target from a weighted average of the one-month SBI rate to the overnight (O/N) interbank rate, adopting international best practices. The ITF monetary policy has been further improved since 2010, with the weekly SBI/SBIS regular auction being changed to a monthly SBI/SBIS regular auction. The purpose of this change is to encourage banks to manage their liquidity over a longer period of time so that the interbank money market will become more active and monetary operations will become more effective. In the second quarter of 2024, Indonesia's economy showed strong growth, supported by robust domestic demand. Export activities increased, particularly in manufacturing and mining sectors, with key trading partners like India and China. Bank Indonesia (BI) maintained the benchmark interest rate (BI-Rate) at 6.25% to support Rupiah stability and ensure inflation remains within the target range of 2.5±1%. This policy is both pre-emptive and forward-looking, aimed at maintaining financial stability and attracting foreign capital inflows. BI also strengthened its monetary policy mix, which includes: optimizing instruments like the Rupiah Securities of Bank Indonesia (SRBI), Foreign Exchange Securities of Bank Indonesia (SVBI), and Foreign Exchange Sukuk of Bank Indonesia; intervening in the foreign exchange market to stabilize the Rupiah; Enhancing monetary policy transmission by adjusting money market interest rates. In this period, credit growth remained high at 12.36% (yoy), reflecting strong demand from both corporations and households, inflation decreased and remained within the target range, with the Consumer Price Index (CPI) inflation recorded at 2.51% (yoy) in June 2024 and the Rupiah strengthened, supported by pro-market monetary policies, despite ongoing global uncertainties. Overall, monetary policies have successfully supported economic and financial system stability. C. MONETARY POLICY DURING THE GLOBAL FINANCIAL CRISIS In July 2007, the global economy faced a financial crisis due to the subprime mortgage crisis in the U.S. banking system. The crisis worsened in 2008, leading to oil prices soaring and commodities falling. The crisis reached a new level of global banking systemic contagion in September 2008, causing business failures, government financial commitments, consumer wealth decline, and economic activity decline. The crisis was transmitted to Indonesia through the capital market, with the composite stock index and Jakarta Islamic Index sliding rapidly. Capital outflows and flight to quality caused persistent pressure on the rupiah, leading to a weakening rupiah. Bank Indonesia entered into a Bilateral Currency Swap Arrangement with the Central Bank of China to prevent further negative sentiment. The crisis intensified after the Lehman Brothers' bankruptcy in September 2008, causing tight liquidity problems in the banking system. The Indonesian government increased the minimum deposit guarantee from Rp. 100 million to Rp. 2 billion to maintain confidence in the banking system. The government established the Financial System Stability Committee (KSSK) to create a financial safety net. In 2009, the banking system escaped systemic risk, and economic growth was better than expected, with inflation rates dropping to 2.78%. However, unemployment increased slightly to 9%. Indonesia was among a few countries with positive economic growth, similar to Brazil, India, and China. D. THE INTRODUCTION OF ISLAMIC MONETARY POLICY The Bank Indonesia Act of 1999 allows the bank to operate on both conventional and shariah principles, aiming to achieve stability in money demand and direct it towards productive activities. Islamic monetary policy focuses on full employment, economic growth, socio-economic justice, equitable distribution of income and wealth, and stability in money value. In 2000, Bank Indonesia introduced Islamic monetary instruments, such as statutory reserve requirements for Islamic banks, a shariah interbank money market, and shariah open market operations. Standing facilities for Islamic banks were introduced in 2003. The statutory reserve requirements for Islamic banks are similar to those for conventional banks, and Islamic banks cannot enter the conventional money market. The SWBI, introduced by Bank Indonesia (BI) as a facility for Islamic banks to place excess liquidity, is a passive monetary instrument with two drawbacks. It is not as active as the SBI, which is an active monetary instrument. In 2008, BI replaced SWBI with the SBIS (SBI Shariah or Bank Indonesia Shariah Certificate), an active monetary instrument using a ju'alah contract to award certain returns for attainments. The reward on the SBIS is benchmarked to the return on the SBI, ensuring consistency and equality requirements. The SBIS allows for dual monetary management, but equalization could deviate from its real essence and objectives. Further studies are needed to find a proper dual monetary policy benchmark and instruments that satisfy all requirements and achieve the intended objectives. E. THE FUTURE OF MONETARY POLICY IN INDONESIA Since the collapse of the gold standard regime in 1915, financial crises have occurred repeatedly, with the most recent crisis in 2008 being the worst since the Great Depression of the 1930s. The Bretton Woods Agreement from 1950-1972, a strict fixed exchange rate international monetary arrangement, helped subsist during this golden age. However, the agreement collapsed in 1971, leading to the adoption of different exchange systems. Since then, financial crises have resurfaced more frequently, with the latest crisis in September 2008 being the worst since the Great Depression of the 1930s. Since then, there have been over 96 financial crises and 176 monetary crises, primarily due to structural failures in different countries and stages of economic development. The current global financial crisis has triggered paradigm shifts and new challenges in effective monetary policy. Alternative financial and monetary systems can be derived from various economic views, such as New Keynesian, Austrian, Lietaer, Binary economics, and Islamic economics. Mainstream economic paradigms have been criticized for their fundamental flaws, leading to repeated financial crises. Non-mainstream economic paradigms highlight root structural causes such as an international money system based on multiple fiat currencies, banking systems based on fractional reserves, speculative behavior, and business cycles. Various views agree on using gold as a resolution to the current money system and a move towards a stable and just global monetary system. Since the revival of Islamic economics and finance in the 1970s, many countries have adopted Islamic finance alongside conventional finance. However, three main pillars of the monetary system still oppose Islamic principles, such as an interest system, fractional reserve banking, and fiat money system. The analysis suggests six characteristics for a future monetary policy framework: avoiding speculative market behavior, being counter-cyclical, counter-inflationary, cost-effective, combining mainstream and Islamic monetary systems, and capitalizing on their superiorities. Indonesia has introduced a dual monetary system, allowing conventional monetary policy to coexist with shariah principles, and allowing people to conduct financial transactions through either system. This dual monetary policy has gradually developed in line with the growth of the Islamic financial system. CONCLUSION REMARKS Bank Indonesia has played a crucial role in stabilizing the country's monetary system since its establishment in 1953. It has faced economic instability, including hyperinflation in the 1960s and global monetary crises. During the second era (1968-1983), it supported the government's development programs, implementing policies to stabilize inflation and promote savings. The 1980s saw a shift towards a market-oriented banking system, leading to increased fund mobilization and improved monetary control. Bank Indonesia transitioned to an independent central bank in 1999, focusing on inflation targeting and monetary stability. Despite facing challenges during the 2008 global financial crisis, its policies helped restore confidence in the economy. Looking forward, Bank Indonesia continues to evolve its monetary policy framework, balancing conventional and Islamic financial principles for long-term stability, inflation control, and sustainable growth. REFERENCES Ananta, A., Soekarni, M., & Arifin, S. (Eds.). (2011). The Indonesian economy: Entering A New Era. Institute of Southeast Asian Studies. Departemen Kebijakan Ekonomi dan Moneter. (2024, 19 September). Laporan Kebijakan Moneter Triwulan II 2024. Accessed on 23 September 2024, from https://www.bi.go.id/id/publikasi/laporan/Pages/TKM-September-2024.aspx DISCUSSION 1.1 Indonesia’s Financial Sector In The Era Of Globalization Indonesia’s financial sector is dominated by commercial banks, which hold 79.5% of the total assets of financial institutions. This heavy reliance on banking creates challenges, particularly during periods of global financial instability. For example, during the global financial crisis, economic uncertainty made banks more cautious, leading to reduced access to funding for the private sector. This affected the performance of the banking industry and slowed down overall economic growth. The crisis led to a deleveraging process, where financial institutions sold off assets to manage risks and strengthen liquidity. In Indonesia, the financial sector is considered "shallow," meaning it is conservative and dominated by banks, which limits its flexibility in responding to global financial pressures. This created a need for banks to find new sources of funding, as interbank loans and securitization activities became limited. There are two major perspectives on Indonesia’s financial stability. One view suggests that the financial sector is robust, able to withstand global shocks due to its conservative nature. The other view argues that while the sector is stable, it lacks innovation, and there is a need for more advanced financial products and solutions to promote higher economic growth. During the 2009 global financial crisis, the challenge of balancing financial stability with economic growth became evident. Indonesia’s Financial Stability Index (FSI) peaked at 2.43 in November 2008, up from 1.60 in June 2008. Although the index later declined, it remained above 2.0, signaling ongoing instability in the financial system even after the crisis had passed. Another important issue is whether financial liberalization in Indonesia contributed to the 1997 economic crisis. Prior to the crisis, Indonesia’s financial sector experienced significant growth following the government’s decision to open up the sector to domestic and foreign capital. While this brought economic expansion, some argue that liberalization also introduced vulnerabilities that worsened the financial crisis in 1997. Additionally, there are questions about whether structural weaknesses in the financial system, such as inadequate regulation or financial practices, exacerbated the effects of liberalization. This suggests that liberalization alone may not have caused the crisis but could have amplified the damage. The deleveraging process, particularly in the US, involved significant asset sales, especially by large banks. From mid-2007 to the third quarter of 2008, an estimated $580 billion in liquid assets was sold, with most of the sales coming from banks in North America and Europe. This process also affected banks in Asia, though Indonesia’s financial sector was relatively less impacted compared to other countries. These developments have led to a debate about the trade-off between financial stability and economic growth. One side emphasizes that Indonesia’s financial system is resilient to external shocks, while the other side believes that the sector needs innovation and diversification to support stronger economic growth. The need for advanced financial products and innovative solutions remains crucial for the sector's development. 1.2 Financial Liberalization And 1997 Economic Crisis Between 1970 and 2000, many countries, including Indonesia, moved towards financial liberalization. This involved changes like lifting interest rate ceilings, lowering reserve requirements, and reducing government control over credit decisions. The goal was to create a stable financial system by ensuring a stable macroeconomic environment, well-regulated financial institutions, efficient financial markets, and reliable payment systems. Indonesia's financial system underwent several phases of liberalization from 1967 to 2001, each with distinct characteristics: a. 1967–1980: During this period, Indonesia focused on controlling inflation through credit and deposit interest rate controls due to high inflation from an oil boom. State banks directed credit to key sectors like manufacturing and agriculture. Liberalization efforts were aimed at attracting foreign direct investment (FDI). b. 1980–1983: A sharp decline in oil prices affected Indonesia’s exports. To address this, the government deregulated the financial sector to boost domestic savings and improve efficiency. Reforms in 1983 included allowing more competition between state and private banks, removing subsidized lending programs, and introducing market-based interest rates. New tools like Bank Indonesia Certificates (SBI) and Money Market Commercial Paper (SBPU) were introduced to manage liquidity. c. 1983–1988: Oil prices fell again in mid-1986, prompting further economic adjustments and financial reforms. In October 1988, a major deregulation package known as "Pakto" was introduced. This allowed more private banks, foreign bank joint ventures, and bank branches outside Jakarta. It also encouraged banks to offer new saving schemes and reduced reserve requirements from 15% to 2%. As a result, there was significant growth in the number of banks, their assets, deposits, and financial products. Simultaneously, reform was introduced in the non-bank sector which energized the capital market a. Capital Market Development (1987-1988): During 1987-1988, reforms were introduced to the non-bank sector to boost investor confidence and create a better investment environment. These changes revitalized the capital market, with the Jakarta Stock Market Index showing strong growth. The capital market started to compete with Indonesian commercial banks, especially for long-term financing, challenging their dominance. b. Banking Reforms (1980-1988): From 1980 to 1988, reforms were focused on strengthening the banking structure in Indonesia, including rules on ownership, management, capital requirements, and lending limits. These reforms aimed to solidify the role of Indonesian banks as key financial intermediaries. c. Acceleration of Reforms (1988-1991): After significant reforms in 1988, banks expanded aggressively from 1988-1991. The government introduced more reforms between 1991-1997, focusing on prudential banking principles, such as capital adequacy and bank ratings, to improve the effectiveness and stability of banks. During this period, Bank Indonesia (BI) issued many new licenses for commercial banks and opened new branches. d. Foreign Capital Inflows: Indonesia’s financial liberalization encouraged banks to seek foreign funds, raising loans through international commercial banks and various financial instruments. Foreign capital became essential for financing economic activities beyond what domestic resources could support. Much of this foreign capital was used for long-term investments, such as large-scale projects in manufacturing, trade, and property sectors. e. Increased Competition and Risk: Financial liberalization significantly changed Indonesia’s financial landscape, increasing competition among banks and between banks and the capital market. As a result, alternative sources of external financing, such as loans, commercial paper, and bonds, diversified. However, commercial banks remained the dominant source of financing, and aggressive lending without adequate prudential measures led to increased risk. f. 1997 Financial Crisis: In September 1997, Indonesia, along with Thailand, South Korea, the Philippines, and Malaysia, was hit by a financial crisis. This led to a sharp decline in bank deposits and loans, and a reduction in the number of commercial banks. Indonesia faced significant pressure on its currency and inflation rates, driven by a weak and highly volatile rupiah. Inflation soared due to a combination of the weakening exchange rate, rising government-regulated prices, and growing inflation expectations. Social and political instability also followed. g. Research Perspectives on the Crisis: Many researchers, including McKinnon, Shaw, and Crockett, saw the financial instability as inevitable after a period of deregulation and liberalization. While these reforms deepened financial markets and increased opportunities for bank credit, they also made the banking system more fragile, eventually leading to financial instability. h. The Link Between Liberalization and Crises: Studies confirmed that financial liberalization increased the likelihood of both currency and banking crises in emerging economies. For example, Weller (2001) found that financial liberalization allowed more liquidity into the economy, which flowed into both productive and speculative projects, increasing vulnerability to crises. i. High Costs of Crisis Resolution: The cost of resolving Indonesia’s financial crisis was the highest among Asian countries, amounting to Rp. 654 trillion (51% of GDP), compared to other countries like Thailand (32.8%), South Korea (26.5%), Japan (20%), Malaysia (16.4%), and the Philippines (0.5%). In response, BI tried to introduce more prudent regulations while continuing banking deregulation. j. Banking Restructuring (1997-2001): The period from October 1997 to 2001 saw a restructuring program under IMF supervision. However, this program faced challenges due to poor planning and political interference, leading to policy inconsistencies. For example, the closure of 16 banks in November 1997 was followed by tight monetary policies, resulting in higher interest rates and a liquidity squeeze. Delays in the restructuring process led to deposit runs on weaker banks, forcing BI to provide liquidity support, primarily to private banks. k. Causes of the Crisis: Radelet and Sachs (1998) identified that the 1997 crisis was largely caused by large-scale foreign capital inflows into a vulnerable financial system. Panic among international investors, along with policy mistakes by Asian governments and poorly designed international rescue programs, turned capital withdrawal into a full-blown financial panic, deepening the crisis. 1.3 Structural Weaknesses In The Financial System Before the 1997 financial crisis, Indonesia underwent a process of financial liberalization, which aimed to boost the economy but had significant downsides, particularly for the banking sector. One major issue was the lack of proper supervision over banks. Bank Indonesia (BI), the central bank, did not have enough staff to properly monitor the growing banking industry. As a result, many banks operated without enough oversight, which made the financial system more fragile and vulnerable to instability. In response to emerging problems, BI implemented temporary solutions rather than addressing the root causes. For instance, when banks faced liquidity problems, BI provided them with emergency loans to prevent a bank run, where customers withdraw all their money in panic. However, this created a "moral hazard" because banks began to rely on these quick fixes and continued to engage in risky behavior, knowing they would be bailed out by the central bank. This further weakened the banking system. Another problem was the concentration of ownership in Indonesia's banking sector. Even though the number of banks increased between 1988 and 1997, a small group of banks, mostly state-owned and a few large private banks, controlled almost all the assets in the industry. Many of these private banks were still owned by their original founders, leading to "information asymmetry," where minority shareholders and creditors did not have access to the same information as the majority owners. This made corporate governance in banks weak and allowed risky lending practices to flourish. In addition to ownership issues, state-owned banks were pressured by the government to lend money to specific sectors or groups, often without conducting proper assessments of the borrowers' ability to repay. This kind of political interference, although less common after 1998, was still a problem and contributed to inefficiencies in the banking system. Furthermore, the influx of foreign capital into Indonesia, especially through short-term loans, added to the fragility of the financial system. International investors preferred short-term loans because of Indonesia's weak institutional structures, like underdeveloped contract and bankruptcy laws. This made it easy for foreign investors to withdraw their money quickly if the economy started to falter, which is exactly what happened during the crisis. The financial liberalization of the 1980s and 1990s did help Indonesia’s economy grow, but it also laid the groundwork for the financial collapse in 1997. Without proper regulations and strong supervision from the central bank, the banking system became more fragile. When interest rates increased, it worsened the situation by creating adverse selection problems, where banks lent money to riskier borrowers because more reliable borrowers could no longer afford the high interest rates. This led to a reduction in the supply of loans and ultimately contributed to the collapse of the loan market. At the same time, Indonesian banks and companies took on large amounts of foreign debt, encouraged by high domestic interest rates and a belief that the government would maintain stable exchange rates. However, this reliance on foreign loans made the country vulnerable when international investors started pulling their money out, triggering a liquidity crisis. 1.4 Three Aspects Of Promoting Financial Stability And Economic Growth a) Improving Bank Capital One of the first steps to make the banking system stronger is to increase the amount of money, or "capital," that banks have. This is especially important for both conventional and shariah banks, including regional government banks (BPDs). By the end of 2008, these banks were required to have at least Rp. 80 billion in Tier 1 capital, and by the end of 2010, this number should be at least Rp. 100 billion. Tier 1 capital is basically a financial buffer that helps banks absorb losses and handle risks. The idea is that the more capital a bank has, the better it can manage risks and support economic growth through lending money to businesses and individuals. However, small banks were struggling to meet this requirement, and tests in 2005–2007 showed that many of them had not made enough effort to build up their capital. This need for higher capital is even more important because of international rules and the fast pace of economic globalization. Indonesia is behind other Asian countries in terms of bank capital, and if this doesn’t improve, Indonesian banks will contribute less to the country’s economy than banks in other countries. So, to help the economy grow while keeping the banking system safe, it’s crucial for banks to raise their Tier 1 capital. b) Strengthening Governance and Performance Even though Indonesia’s banks are in a healthy state today, there is still room for improvement, especially in how banks are managed (called "corporate governance") and their banking skills. Many banks need to be better at managing risks, especially operational risks like internal controls and making sure they follow banking rules. These rules are based on international standards, such as the 25 Basel Core Principles for Effective Banking Supervision. Another issue is that, although banks in Indonesia are profitable and show good returns (like Net Interest Margin, Return on Equity, and Return on Assets), they also have very high operating costs compared to other countries. For example, the money they make outside of interest comes mostly from trading activities, which can change quickly and unpredictably. Additionally, Indonesian banks have fewer assets per customer, meaning they spend more to run their operations than banks in other countries. To help the economy grow, banks need to find ways to reduce their operating costs and improve efficiency. If banks can do this, they will be more stable and profitable in the long run, contributing more to the country’s economic growth. c) Improving the Effectiveness of Banking Supervision The third strategy is about making sure that banks are properly supervised and regulated. In the past, some banking rules were not enforced effectively because bank supervisors didn’t have the right skills or knowledge. This lack of proper supervision contributed to financial problems, including during the 1997 financial crisis. To avoid such issues, Bank Indonesia (BI) is working to improve bank supervision, including using new technologies to monitor banks. This is part of an effort to follow the Basel Core Principles for effective banking supervision. Since the banking industry is always changing and growing, it’s important that supervision is updated regularly and becomes a routine part of managing banks. Another big challenge is banking fraud, which affects both the banks and society. To deal with this, banks need clear and easy-to-understand rules for how they supervise their activities, handle customer complaints, and share information about their products. Transparency is key to building trust and keeping the financial system healthy. CONCLUSION Indonesia’s financial sector has undergone significant changes over the past few decades, shaped by both external and internal challenges. The country's reliance on commercial banks, which dominate the financial landscape, has created vulnerabilities, particularly during global financial crises. The 1997 financial crisis, for example, exposed the structural weaknesses within Indonesia's financial system, especially in terms of inadequate supervision, ownership concentration, and heavy reliance on foreign capital. Financial liberalization in Indonesia, aimed at fostering economic growth, brought both opportunities and risks. While it opened the door to foreign capital and increased competition, it also made the banking system more fragile. The 1997 crisis highlighted how the lack of proper regulatory frameworks, combined with the influx of foreign short-term loans, exacerbated financial instability. The country's banking system became vulnerable to external shocks, such as capital outflows and currency fluctuations, leading to a liquidity crisis. To address these challenges, several measures have been identified to promote financial stability and economic growth. These include: a. Improving bank capital: Ensuring banks, both conventional and shariah, have sufficient capital to absorb risks is essential for the sector’s resilience. b. Strengthening governance and performance: Enhancing corporate governance, managing risks, and reducing operational costs are critical for long-term profitability and stability. c. Improving the effectiveness of banking supervision: Better supervision, adherence to international standards, and increased transparency are vital for preventing future financial crises. In conclusion, while Indonesia’s financial sector has made progress, there is still a need for more robust regulation, innovation, and diversification to ensure both financial stability and sustainable economic growth. Strengthening the banking system through better capital management, risk mitigation, and effective supervision is essential for reducing vulnerabilities and enhancing the country’s economic resilience in an increasingly globalized world. TOPICS In 2008, a global financial and economic crisis occurred, causing a global recession that affected many countries, including Indonesia. Export revenues fell, consumer confidence dropped, financial institutions collapsed, and thousands of people became unemployed. However, Indonesia's impact was relatively mild compared to other ASEAN countries due to its low reliance on exports and strong domestic consumption. To counter this, several policy measures were introduced, including active monetary policies and an emergency fiscal stimulus package. A. HISTORICAL OVERVIEW OF INDONESIAN FISCAL CONDITIONS In the late 1960s and early 1970s, the Indonesian economy underwent a significant transformation under Soeharto's New Order government. The government launched fiscal and monetary initiatives to combat inflation, open up the economy to international trade, attract foreign investors, and promote the oil and gas sectors as major revenue generators. However, these initiatives also led to the economy becoming heavily dependent on the oil and gas sector, increasing its share of revenue to the total government revenue from 20% to over 50% in 1970s. This reliance made the Indonesian economy susceptible to external shocks, such as the 1980s oil price shock, which led to a major fiscal imbalance. The government responded by diversifying its revenue base, boosting revenues from non-oil and non-gas sectors, and increasing revenue from value added tax (VAT). However, the government struggled to mobilize revenue from corporate and personal income taxes, which only increased significantly in the mid-1990s. As the economy grew, government expenditure also increased, accounting for nearly 27% of GDP in the period of 1980-81. The government decided to diversify its revenue base further, but since the domestic financial sector was not strong enough to provide necessary financing support, the government decided to tap into foreign aid and borrowings to maintain a balanced budget (Anggaran Berimbang-Dinamis). The Indonesian government's decision to increase foreign aid and borrowing in 1990, coupled with the globalized world financial market, which led to a dramatic increase in the foreign aid and borrowing components of the budget. It increased foreign borrowings created an additional burden on the government budget in the form of debt and interest obligations. The 1997-98 crisis exposed Indonesia's currency to massive downward pressure against the U.S. dollar and put the Indonesian economy under heavy inflationary pressure. Anxious to provide short-run fiscal stimulus, the government increased expenditure and fuel subsidies to help the middle and low income groups. However, the massive depreciation of the Indonesian currency by nearly 250% severely escalated the amount of foreign debt obligations, leading to a huge budget deficit. The Indonesian parliament passed constitution laws on decentralization, regional autonomy, and fiscal budget, granting autonomy to local governments to manage their own fiscal administration and budgetary systems without central government intervention. The central government also provided regional governments with a "balance fund" to finance the needs related to the implementation of decentralization policy. In 2002, the government took the initiative to generate publicly financed funds by issuing government bonds (SUN) and selling them in the domestic market. This move was successful in generating more funds and reducing the dependency of the Indonesian economy on foreign borrowing. Throughout the 2000s, Indonesia maintained its deficit at a manageable level, maintaining a surplus balance of financing (SILPA) of around 80 IDR trillion. However, the increase in government revenue did not lead to an increase in government expenditure, resulting in inefficient budget absorption. B. THE INDONESIAN FISCAL OUTLOOK DURING THE GLOBAL FINANCIAL CRISIS The Indonesian economy faced significant fiscal burdens during the global financial crisis in late 2008, which led to a contraction and reduced economic growth. In 2009, Indonesia's economic growth was the second highest among ASEAN countries, behind Vietnam. This was due to the larger share of domestic consumption in GDP than exports, and the country's non-trade dependence. The 2009 parliamentary and presidential elections, which involved around 140 million eligible voters, also contributed to the mild impact of the global economic downturn on the Indonesian economy. However, the global financial crisis negatively impacted the government's budgetary conditions, as the slowdown in world demand reduced domestic economic activities, reduced national income, and shrank the income tax base. The government responded by lowering revenue and expenditure projections and launching a fiscal stimulus package to boost the domestic economy. By the end of 2008, the Indonesian government had an actual cash surplus of over 61 IDR trillion. a) Government Revenue In 2007 and 2008, the Indonesian Government experienced a significant increase in revenue, which was higher than the budgeted revenue. This increase was attributed to the rise in various tax and non-tax revenues, including VAT revenue. The soaring world crude oil price in 2008 benefited tax and non-tax oil and gas revenue, which grew by about 75%. Income tax revenue from non-oil and non-gas sectors also increased significantly due to the successful implementation of the "sunset policy" and the "taxpayer registration policy." These policies increased the tax collection rate to about 29% in 2008. However, the global economic crisis in late 2008 and early 2009 slowed down economic activity, reducing tax revenue significantly. The government provided cuts in personal income tax rates and increased the tax-free income base as part of its fiscal stimulus package, leading to further reductions in tax revenue. According to Indrawati et al. (2024), Indonesia’s fiscal policy appears to have been effective in cushioning shortterm shocks as the monetary authority focused on economic stability. Nonetheless, medium to long-term challenges need ongoing attention. Fiscal policy plays a crucial role in easing efforts to address those issues. The government-initiated tax reforms through Law 7/2021 on Tax Harmonization, in which the hike in the value-added tax rate resulted in a revenue gain of around Rp 60 trillion during April–December 2022. b) Government Expenditure The Indonesian Government's conservative spending approach in 2008 resulted in a lower than expected budget deficit, with the actual deficit being 4.1 IDR trillion, much lower than the budgeted level of 94.5 IDR trillion. This was due to the fear that a large budget deficit would worsen the deficit. However, the difference between the actual and budgeted deficits suggests a deeper structural problem, such as inefficiency in absorbing the budget. The actual capital expenditure in 2008 was 71.2 IDR trillion, while the budgeted capital expenditure was 79.1 IDR trillion. The proportion of budget allocated to line ministerial posts was also lower than its budgeted amount. Non-line ministerial posts accounted for nearly 60% of total government expenditure, with 58% allocated to subsidies and interest debt payments. In the first semester of 2008, Indonesia's expenditure on subsidies increased more than twofold compared to the same period in 2007, despite a reduction in fuel subsidies. The actual amount of subsidies was larger than their budgeted amount. Line ministerial expenditure was mainly allocated to administrative, material, and personnel expenses, rather than development-related project expenses. The budgeted expenditure allocated to both administrative and personnel expenses constituted about 65.8% and 73.7% of total line ministerial expenditure, respectively. The Government tended to allocate a larger budget for consumption spending, rather than for investment spending. This imbalance in budget allocation could have slowed the growth of productive capacity. In 2009, the government increased the budget allocated to line ministerial expenditure by 8.5% or 24.7 IDR trillion more than the previous year, while cutting the budget allocated to non-line ministerial expenditure by 7.4% or 30.2 IDR trillion less. The Ministry of Education received 19.3% of the total budget, while the Ministry of Public Works received nearly 11%. The remaining two ministries received 7.7% and 6.3% respectively. The government aimed to stimulate physical and human capital investments to enhance national productive capacity. The state expenditure in 2023 aimed to support economic activity, protect purchasing power and support agendas such as stunting reduction, extreme poverty reduction, El Niño mitigation, election preparation and priority infrastructure development, including the construction of Indonesia’s new capital city. This spending representing 0.8% in growth compared to 2022 (Indrawati et al., 2024). c) Government Financing Since 2002, the Indonesian government has been issuing bonds to domestic investors to diversify its funding source. However, due to the underdevelopment of the domestic bond market, the government decided to offer its bonds to foreign investors in 2006. Foreign investors, primarily domestic insurance and mutual fund companies, gained interest in government bonds with short-term maturity. The proportion of foreign investors holding government bonds increased by about 17% annually from 2007-09, and in 2007-09, the proportion of government bonds held by individual domestic investors grew by 41.6% annually. The government funding generated from the bond market significantly reduced the dependency of the Indonesian economy on foreign borrowings. In 2008, the revenue generated from government bonds stood at 85.9 IDR trillion, or 83.8% of total revenue. However, the global financial crisis in 2008 halted the promising role of government bonds, which destroyed investor confidence. The government diversified its bond products with Islamic compliant bonds, such as sukuk and samurai bonds, and shifted foreign investors' holding of government bonds from short-term to long-term ones. These innovations helped the Indonesian Government maintain a high level of expenditure in 2010, with a large surplus in its "financing balance" (SILPA) of IDR 80 trillion in 2008. This allowed the government to finance its fiscal stimulus package. According to the Asian Development Bank (2024), in 2023, PT Sarana Multigriya Finansial, a state-owned secondary finance company, issued a social bond worth IDR 500 billion and a social sukuk worth IDR 200 billion, aimed at financing affordable housing projects for low-income earners. This marks the first issuance of labeled social bonds and sukuk in compliance with sustainability-related bond regulations set by the Financial Services Authority. C. FISCAL STIMULUS PACKAGE The choice between monetary and fiscal policies for stabilization is a long-standing issue in economic discourse. Monetary policy uses money supply, exchange rates, and interest rates to expand or contract aggregate demand and supply, while fiscal

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