developing. At the same time, Indonesia's poverty rate fell from 28% in the mid-1980s to around 8% in the mid-1990s, compared with a decline from 29% to 27% for all developing countries (except China). Indonesia's performance is comparable to that of other countries such as China and Thailand, whose economies have grown faster.
Economic reforms in Indonesia focused on reorienting the economy to reduce dependence on the oil sector, expanding the role of the private sector, and encouraging the creation of a competitive, export-oriented non-oil industry that could rapidly absorb a large labor force. This strategy required coordination between fiscal and exchange rate policies, aiming to create a stable macroeconomic environment, accompanied by structural reforms to promote sustainable growth and economic diversification. The main reform elements during 1985-1996 included the gradual liberalization of foreign direct investment inflows to promote non-oil exports and economic diversification, maintaining a competitive exchange rate, trade liberalization and tariff reform, improving monetary management, and reforming the financial sector through liberalization of external capital flows, promoting competition in the banking sector, strengthening financial institutions, and encouraging capital market growth.
In 1985, Indonesia maintained a regime of free capital outflows for individuals and institutions, while prohibiting commercial banks and financial institutions from lending to foreign countries. Restrictions on outflows through financial institutions remained in effect throughout the period. Selective controls were imposed on capital inflows, direct investment was restricted by domestic ownership requirements; foreign investors' purchases of shares in the domestic stock market were prohibited, and restrictions were imposed on foreign loans. Trade policy remained essentially protectionist.
During much of this period, financial integration was promoted through gradual increases in direct investment inflows and liberalization of the tariff system. Direct investment inflows were liberalized by expanding the sectors in which such investments were permitted, by restricting equity ownership rules to the production of certain goods and investment in certain sectors, and by lengthening the period in which a firm would have to revert to domestic ownership.
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The exchange rate was devalued in 1983 and then in 1986, the exchange rate was adjusted to market conditions as part of the economic restructuring package. Payment and remittance activities were also liberalized for
international current transactions under Article VIII of 1988. Foreign exchange markets were developed and the sale of swaps in the foreign exchange market was liberalized. These reforms were associated with a greater openness of the economy (measured by the ratio of total exports to imports to GDP) and with faster economic growth.
The 1988 reforms focused on the operation of the banking system, improving banking supervision and developing the money market. Financial sector reform was promoted by allowing more commercial banks to participate in the financial sector, creating a level playing field for foreign and domestic commercial banks.
Then, in 1989, the authorities liberalized portfolio capital inflows by removing quantitative restrictions on commercial bank loans to non-residents. Foreigners were allowed to invest in the stock market and acquire up to 49% ownership of listed stocks. Restrictions on direct investment inflows were also further relaxed, and foreign direct investors were allowed to sell foreign exchange directly to commercial banks rather than through the central bank.
In 1990–1991, the Indonesian economy began to overheat, with a widening current account deficit, rapid inflation, and a significant increase in interest rates. However, in the context of maintaining a stable real exchange rate, the increase in interest rates was accompanied by a significant foreign capital inflow, and total private net capital inflows registered a surplus in 1990 for the first time since 1985. Foreign capital inflows were mainly in the form of commercial bank loans converted into domestic currency using the central bank's swap operations, thus contributing to the acceleration of the currency's growth rate. Monetary restraint was supported by a tight fiscal policy to limit demand pressures, but inflation continued to trend upward.
During the period 1985-1996, the poverty gap and the poverty rate in Indonesia tended to decrease steadily, fluctuating between 10-15%. The main determinants of poverty reduction in Indonesia in the 1990s were the efforts to implement economic growth policies and reasonable social policies.
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Poverty Gap ($1.90/day)
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Figure 2.3. Poverty line level according to poverty gap index and poverty rate in Indonesia
Source: World Bank
Capital inflows to the commercial banking sector were so large and difficult to manage the macroeconomy that the authorities reimposed quantitative controls on foreign borrowing by commercial banks and state-owned enterprises in 1991. Restrictions on foreign borrowing by the public sector remained in place from 1992 to 1996. However, the authorities continued to expand foreign borrowing arrangements for commercial financing to private entities, including the sale of securities to non-residents, and the liberalization of foreign direct and portfolio investment through the stock market as part of the development of the overall economic and financial sector. These measures were taken in conjunction with other measures to strengthen the domestic capital market and the legal framework for banking. In particular, during 1995-1996, regulations were issued to strengthen financial institutions through upgrading accounting standards to ensure compliance with prudential guidelines and through derivative instruments to prevent excessive risk taking.
During the first half of 1997, in the process of financial integration, Indonesia continued to attract foreign investment flows. The Central Bank of Indonesia took measures to limit credit growth including: partial elimination of the sale of central bank certificates, increased reserve requirements, and reduced subsidized credit to state-owned enterprises.
Initially, Indonesia managed the regional currency crisis that began in June 1997 better than its neighbors because of stronger fundamentals, including a relatively smaller external current account deficit. However, on 11 July 1997, to guard against speculation, Indonesia widened the trading band for its exchange rate against the US dollar from 8% to 12%. Subsequently, concerns also arose about the stability of the banking system and the Indonesian Rupiah came under speculative pressure and was allowed to float.
The Asian financial crisis hit the Indonesian economy hard, causing per capita GDP to fall by 13% in 1998 from its 1994 level. The poverty rate rose sharply from 17.7% in 1996 to 24.2% in 1998 (ADB, 2000). This shows that poverty in Indonesia responds quite strongly and relatively quickly to major shocks. Although the Asian crisis has adversely affected the well-being of the Indonesian people, the country's economic and human development achievements over the past quarter century have been impressive, especially compared to those of South Asia and other low- and middle-income countries (ADB, 2002).
2.4.3. Thailand's financial integration roadmap and poverty reduction
During the early period of 1985-1997, Thailand made major adjustments. According to the ADB report (2002), in the process of financial integration, the baht was devalued by 14.8% in 1984, export-oriented industrial and trade policies were implemented, and Thailand prioritized promoting capital inflows through tax and institutional reforms and financial market development. This policy, together with a large positive interest rate differential and a fixed exchange rate, promoted net capital inflows. These capital inflows contributed to a strong push for financial integration. However, concerns about exchange rate stability and the solvency of the financial system later led to a sharp reversal of capital flows and the cause of the currency crisis.
Trade and financial integration, especially the attraction of foreign capital, has had a strong impact on Thailand's poverty reduction. Data from the Socio-Economic Survey (SES) (2002) show that income poverty fell sharply from 1988 to 1996, from 18 million to 7 million. However, the onset of the economic crisis halted this impressive pace of poverty reduction. The poverty rate rose from 11.4% in 1996 to 13% in 1998. During the period 1985-1997, although the proportion of poor and
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The poverty gap in Thailand had been on a declining trend, but increased much more sharply from 1998 to 1999.
Figure 2.4. Poverty line level according to poverty gap index and poverty rate in Thailand
Source: World Bank
During the early stages of financial integration from 1985 to 1997, Thailand maintained capital account openness in relation to capital inflows. Under the Foreigners Business Act of 1972 and the Investment Promotion Act of 1977, foreign investment sectors were liberalized. Portfolio investment flows were liberalized, although exchange rate controls were initially imposed on the repatriation of interest, dividends, and principal. Foreign borrowing could be freely undertaken but had to be registered with the Bank of Thailand (BOT).
During this period, foreign capital inflows were promoted through various measures including: removing restrictions on foreign investment and foreign ownership of export-oriented industries; providing tax incentives to encourage direct investment in industries; providing tax incentives for foreign mutual funds to invest in the stock market, and the creation of new closed-end mutual funds; establishing foreign rules on the issue of debt of Thai companies; reducing taxes on dividends remitted abroad; and allowing foreign investors to freely repatriate investments, repay loans, and pay interest.
Payments and transfers for current international transactions were also gradually liberalized, and in 1990 Thailand accepted to implement the obligations of Article VIII.
A greater degree of liberalization is reflected in the removal of restrictions on the amount of foreign exchange that can be purchased or brought into or out of the country, and the expansion of the use of non-resident baht accounts and resident foreign currency accounts.
In contrast to the rapid acceleration of capital inflows, controls on resident capital outflows were only gradually liberalized. In 1990, commercial banks were allowed to lend limited amounts in foreign currency to nonresidents and to repatriate proceeds from the sale of securities to the home country, and in 1991 Thai residents were allowed to invest abroad or lend certain amounts to companies with at least 25% Thai equity participation. This lending limit was increased in 1994. Purchases of foreign capital and money market securities, foreign direct investment exceeding US$10 million, and purchases of real estate still require approval from the Bank of Thailand (BOT). Insurance companies are allowed to invest abroad in certain cases but only up to 5% of their total portfolio, while domestically issued mutual funds are restricted to investing their total portfolio in the domestic market.
Domestic financial market reforms initially focused on the development of the stock market. The Stock Exchange of Thailand (SET) was established in 1975, and the Securities Exchange Act was amended in 1984. During this period, the number of listed companies on the exchange more than tripled, and the average annual growth in stock market capitalization was a remarkable 57% during the period 1987-1994.
Following the financial crisis in the first half of the 1980s, measures to strengthen the commercial banking system were introduced in 1985, including strengthening prudential standards and improving internal and external supervision. However, the commercial banking system continued to exhibit a monopoly through large spreads between deposit and lending rates. Furthermore, the 1997 banking crisis revealed that there were some weaknesses in the financial sector that had not been fully addressed after the previous banking crisis.
Although net direct investment inflows contributed to the initial strengthening of the capital account, net portfolio investment inflows became more important in Thailand, and the government introduced further reforms to promote investment in the stock market. The share of short-term net inflows rose to 60% of the total in 1995. Consequently, in 1995, Thailand began to restrict short-term inflows by imposing a 7% reserve requirement on its baht accounts.
non-residents in banks. These restrictions were extended in 1996, to cover foreign loans of less than one year.
In 1996, growth and investment slowed due to real exchange rate appreciation and a sharp decline in capital inflows and exports. A large current account deficit, high interest rates, and rising inflation left the country vulnerable to external shocks and changes in market sentiment. Furthermore, serious weaknesses emerged in the financial system due to inadequate loan provisioning. High interest rates to counteract outflows exacerbated the solvency and liquidity positions of many commercial banks and financial companies and led to intervention by the authorities to support the financial system. In July 1997, faced with a banking crisis, monetary policy, and exchange rate losses, the authorities floated the baht and adopted a managed float exchange rate regime.
An important cause of the currency crisis is the impact of currency speculation. This shows that one of the most important lessons for financial integration is to have policies to prevent the risk of currency speculation. In addition, financial integration can also easily cause a sudden increase in cash flow into real estate, increasing the risk of external balance when USD debt increases but the ability to create USD (production - export) does not increase. This is also an important cause leading to the 1997 Asian financial crisis.
In response to the currency crisis, foreign exchange sales were restricted for all foreign exchange transactions except those related to exports and imports of goods and services, direct investment, and portfolio investment. Forward settlement transactions in baht with non-residents and sales of baht to purchase foreign currency by non-residents were temporarily restricted. However, such measures did not generally prevent the sale of domestic currency, and the baht continued to depreciate.
According to the ADB (2002), the economic crisis in 1997 caused the poverty rate in Thailand to increase from 11.4% in 1996 to 12.9% in 1998 and 15.9% in 1999. The poverty rate in urban areas decreased by about 19% from 1996 to 1999, while in rural areas, the poverty rate increased by 44% and 52%, respectively. The crisis that began in the financial sector in Bangkok had a more severe impact on rural areas. The reduction in employment opportunities in modern sectors caused the labor force from Bangkok and its suburbs to migrate to rural areas, resulting in an oversupply of labor for non-agricultural jobs. Real wages fell significantly in rural areas, causing a decline in household income.
2.4.4. Lessons learned on financial integration roadmap and poverty reduction policies for developing countries in Asia in the period 2005-2018
Lesson One, on the Sequence and Speed of Financial Integration for Developing Asian Countries:
In the process of financial integration, the liberalization of capital flows into direct investment is often implemented as part of larger strategies to restructure the real sectors of economies. Portfolio capital flows liberalization is often coordinated with domestic financial sector reforms, in particular domestic interest rate liberalization and the shift to indirect monetary instruments, the strengthening of domestic stock markets, and domestic commercial banking and foreign exchange market reforms. In Chile, the financial integration roadmap began with financial sector reform before capital account liberalization, while in Indonesia capital account liberalization helped accelerate the restructuring and competitiveness of the domestic financial system. For Thailand, the currency crisis highlighted the risks of financial integration, especially capital account liberalization, which does not include all the necessary simultaneous reforms.
In the process of financial integration, when liberalizing the capital account, the approach to liberalizing capital inflows and outflows varies depending on the specific priorities adopted by the country. Thailand actively promoted capital inflows while restricting outflows with the aim of supplementing domestic savings and promoting investment and rapid economic growth. Indonesia maintained a relative liberalization of capital outflows and gradually liberalized capital inflows with the aim of attracting foreign capital to support economic restructuring. Chile also liberalized capital inflows as part of its economic restructuring strategy and liberalized outflows to contribute to the balance of payments equilibrium.
In the process of financial integration, the pace of domestic financial system reform and capital account liberalization varies from country to country. Chile adopted a gradual approach to financial system reform followed by capital account liberalization. Indonesia, on the other hand, liberalized capital outflows early in the process of domestic financial system reform and then gradually liberalized capital inflows over a long period of time. Thailand opened its economy to capital inflows, especially portfolio inflows, much faster than Chile and Indonesia, but liberalized capital outflows gradually.