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  • Financial Fragility and Instability in Indonesia
  • Karyn Wang
Financial Fragility and Instability in Indonesia. By Yasuyuki Matsumoto. Oxon: Routledge, 2007. Pp 258.

With the global conversation on financial stability taking flight around Basel II, Financial Fragility and Instability in Indonesia by veteran banker Yasuyuki Matsumoto offers an astute response to the ongoing debate. This timely volume on the causes of the 1997 financial crisis in Indonesia recentres our attention from the common macroeconomic focus on the role of the Central Bank to the importance of microeconomic activities of capitalists and their institutions. As the country most severely hit by the financial crisis, Indonesia serves as an unambiguous expression of the destructive effects of financial fragility and instability. Using four Indonesian conglomerates as case studies, Matsumoto argues that the seeds of the financial crisis were sown during the years of rapid economic development from 1994 to 1997. Unsound financial structures, sharp increases in corporate leverage, reliance on external debt, and availing of riskier and more complicated financial instruments by Indonesian corporate empires rendered the financial system profoundly unstable.

Matsumoto's approach of examining the microeconomic terrain of Indonesia's large [End Page 280] conglomerates is a departure from conventional approaches that attribute the root causes of the financial crisis to shaky macroeconomic fundamentals. In explaining contagion of financial crises in Southeast Asia, many accounts ascribe the financial meltdown to ineffective supervision and lax regulatory enforcement actions in the banking sector. This study reveals that the emphasis on the role of domestic banks in the precipitation of the financial crisis in Indonesia is misplaced. Prior to 1997, domestic banks' access to offshore funds was under firm prudential control and their external debt levels were sustainable. In fact, this volume demonstrates that "the rapid accumulation of external debt by the Indonesian corporate sector during this period was more important than debt build-up in the state and/or banking sector" (p. 44).

To support his argument that the microeconomic foundations of Indonesia's corporate sector directly contributed to the financial crisis, Matsumoto presents an anatomy of Indonesia's debt from the early 1990s and highlights the heightened use of offshore loans for investment. The heavy reliance on offshore markets and foreign exchange debt left the microeconomic financial structure in Indonesia fragile and unstable. It also placed limits on the country's financial economy and left it vulnerable to external shocks. Grounding his main thrust in Hyman Minsky's hypothesis of financial instability, Matsumoto traces the descent from risky cash flow positions and unmitigated offshore borrowing to crisis. Briefly, Minsky's financial instability hypothesis states that characteristics endogenous to a dynamic, capitalist economy, such as speculative finance and debt deflation, cause a financial system to evolve from being robust to being fragile. This volume modifies Minsky's financial instability hypothesis for an open and developing economy context. As causes of the financial crisis, Matsumoto cites the dominance of speculative financing units, the problem of leverage, foreign exchange risk related to unhedged liability positions, piecemeal liberalization policies, and offshore banks' sudden and aggressive withdrawal of funds.

Based on this assessment, Matsumoto examines three issues as contributors towards financial system instability and fragility, namely, the financial positions of Indonesian private non-financial firms, the offshore debt transactions of Indonesian debt borrowers, and financial activities of selected major Indonesian business groups. Delving into corporate finance, four in-depth case studies outline the microeconomic foundations of the financial crisis. Matsumoto selects the Salim Group, the Lippo Group, the Sinar Mas Group, and the Gajah Tunggal Group. Characteristic of Indonesian capitalists, these four prominent conglomerates sought to liquidate their assets without losing control of their corporate empires — by taking advantage of increased access to foreign loans and complex financial re-engineering, actions which ultimately ushered instability and crisis throughout the entire financial system.

The author provides evidence that the enthusiasm of offshore lenders to lend to Indonesian firms exerted considerable upward pressure on the debt market. As offshore syndicated debt became the favoured device for leveraging the financial structure of conglomerates, bargaining power shifted from offshore lenders to Indonesian borrowers. With improved terms of borrowing came higher borrowing volumes, decreasing costs, and an enlargement of the range...

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