IMF programs, financial and real sector performance, and the Asian crisis
Journal of Banking & Finance
journalhomepage:www.elsevier.com/locate/jbf
IMF programs, financial and real sector performance, and the Asian crisis
b , d Ali M. Kutan e ⇑ , Gulnur Muradoglu , Brasukra G. Sudjana
a Department of Economics and Finance, Southern Illinois University, Edwardsville, IL, USA
c The Emerging Markets Group, Cass Business School, City University, London, UK d William Davidson Institute, University of Michigan, 724 East University Avenue, Ann Harbor 48109-1234, USA e British Embassy, Jakarta, Indonesia Cass Business School, 108 Bunhill Row, London EC1Y 8TZ, UK
article info
abstract
Article history: This paper has three objectives. First, using a richer and more comprehensive set of IMF-related news Received 18 July 2008
than previous studies, we examine the impact of IMF-related news on both financial and real stock sector Accepted 24 June 2011
returns in Indonesia during the Asian crisis. Second, we draw lessons about financial and real sectoral Available online 8 July 2011
patterns of adjustment in crisis countries, including whether and how IMF programs facilitate this adjust- ment. Third, we explore the interplay between IMF actions in crisis countries and the actions and
JEL classification: responses of local authorities. To do so, not only do we account for the impact of news regarding IMF pol- F32 F33
icy actions but also the government’s reaction to them and willingness to implement such policies, and F34
the public sentiment about the implemented IMF programs and government policies. We discuss the pol- G15
icy implications of the findings.
Ó 2011 Elsevier B.V. All rights reserved. Keywords: Asian crisis Event study Financial and real sector returns IMF policy News
1. Introduction example, regarding the nature of IMF programs during the Asian crisis, Michael Camdessus, then the Managing Director of the
In the past decade several countries have experienced financial IMF, stated: ‘‘Instead of austerity measures to restore macroeconomic crises and many of them have turned to the IMF for assistance. In
balance, the centerpiece of each program is a set of forceful, far-reach- turn, the IMF has advised the crisis-countries and imposed some
ing structural reforms aimed at restoring market confidence. The tough conditions to relieve the negative effects of the crisis and
reforms included in these programs will require vast changes in move the economy on a growth path. 1 domestic business practices, corporate culture, and government
However, the impact of fund programs on financial market behavior’’ (IMF Survey, Volume 27(4), February 23, 1998, p. 49). recovery in a crisis is highly debated. There are conflicting views
On the other hand, other scholars dispute this view and argue that of the success of the IMF in helping the affected countries recover
such structural and microeconomic conditions imposed by the IMF from the crisis and establish long-run economic growth. First,
undermine political support for necessary reforms and hence may some observers argue that IMF programs restore investor
destabilize investor confidence ( Eichengreen, 2000 ). Regarding the confidence and are therefore necessary for financial stability. For
IMF assistance to Mexico in 1995, Friedman (1998) argues that IMF assistance may create creditor moral hazard in that it encourages
⇑ Corresponding author at: Department of Economics and Finance, Southern investors to take on excessive risk because they believe that Illinois University, Edwardsville, IL, USA. Tel.: +1 618 650 3473; fax: +1 618 650
expected IMF support to a crisis-country provides implicit guaran- 3542.
tees to its creditors (i.e. IMF bailouts) when they lend and invest in E-mail addresses: akutan@siue.edu (A.M. Kutan), G.Muradoglu@city.ac.uk
countries in trouble. In addition, some observers argue that the IMF (G. Muradoglu), 1 brasukra@yahoo.com (B.G. Sudjana).
may act as a lender of last resort in a crisis by making sufficient For detailed studies of the crises and the IMF’s response, see, among others, Lane
et al. (1999) and the IMF Independent Evaluation Office report (2003) . For discussion funds to crisis countries and hence can play the role of an interna- of IMF conditionality and its effects in emerging markets, see Dreher and Vaubel
tional financial institution and secure a world financial order, while (2004), Erbas (2004) , and Evrensel (2004) .
others suggest that such lender of last resort operations may not be 0378-4266/$ - see front matter Ó 2011 Elsevier B.V. All rights reserved.
doi: 10.1016/j.jbankfin.2011.06.015 doi: 10.1016/j.jbankfin.2011.06.015
Overall, the impact of IMF programs on crisis countries seems ambiguous. In this paper, we further investigate the impact of IMF actions on private financial markets and provide evidence on the effectiveness of IMF assistance on asset market performance in Indonesia during the Asian financial crisis. We focus on Indone- sia as its economy suffered the most from the crisis in the region. According to Berg (1999) , in 1998 real GDP of the Indonesian econ- omy declined by 13.7%, but the decline was much smaller in Korea (5.8%) and in Thailand (about 9%). At the beginning of the crisis, the Indonesian government also signed several agreements with the IMF and the advice continued after the first agreement signed on October 31, 1997. In addition, during the crisis period, there had also been several policy actions by the government, either inde- pendent of IMF programs or in conflict with the IMF’s position, such as the introduction of a currency board. Such government ac- tions might have further contributed to the crisis to the extent that investors perceived such actions not credible because of the poten- tial special relationship between the government and corporate sector. Berg (1999) , for example, argues that the close relationship between government officials and the banking system as well as certain private sector participants, especially in Indonesia and Kor-
ea, brought about weaknesses in corporate governance and, among others, augmented the crisis in important ways. We contribute to the literature on the effects of IMF programs on financial markets from three different perspectives. First, we provide comprehensive evidence about the overall effectiveness of IMF programs in Indonesia. If a large IMF assistance program reduces the probability of a crisis and reduces the amount of illiq- uid investments that need to be liquidated in a crisis country, then such IMF support in terms of more liquidity injection can encour- age private investors to retain their funds in the program country. Assuming limited moral hazard, liquidity support by the IMF may encourage a program country government to have incentives to implement IMF’s costly policies and reforms. In this case, we ex- pect an increase in the program country’s stock returns, suggesting that IMF programs can be effective in crisis countries. Besides its importance for investors, our results have implications for the role of the IMF as the lender of last resort and hence contribute to the recent debate on the effectiveness of international institutions in securing a world financial order.
Second, we investigate the relative impact of the programs across different economic sectors. This investigation helps us to draw lessons about sectoral patterns of adjustment in crisis coun- tries, including whether and how IMF programs facilitate this adjustment. Although a growing number of studies have examined the impact of IMF actions on asset market returns (see the next section), the majority of these studies focus mainly on financial sector returns because this sector is believed to be at the center of the reasons for the financial crisis ( Stiglitz, 1999; Williams and
Nguyen, 2005 ). 3 We also focus on the real sector because IMF ac- tions do not only affect the financial sector, as significant changes in real sector returns also take place. Besides the banking sector, we provide evidence on the financial sector that includes insurance, investment companies, real estate, and other related financial sec- tors. In addition, we include three major real sectors, namely, basic materials, consumer goods, and industrials. Basic materials include basic resources, chemicals, forestry and paper, metal and mining. The industrial sector, which includes aerospace and defence, diversi-
fied industrials, electronic and electrical goods, accounted for the largest share of GDP during the crisis period. The consumer goods sector includes automobiles and parts, food and beverages, health, household goods and textiles, personal care, pharmaceuticals and to- bacco, and accounted for some 25% of GDP in 1998. The biggest com- panies in these three real sectors were also owned by the same conglomerates that in turn owned banks, which failed during the cri- sis. It is, therefore, interesting to see whether the performance of the real sectors is similar or different from that of the banking and the financial sectors. During the Asian crisis, the IMF recommended tight monetary policy and advised high interest rates in order to restore confidence in the currency. There is, therefore, a good reason to think that the effects of IMF news might affect the financial and real sec- tors differently, especially if there are different factors driving differ- ent sector returns, such as international commodity prices (for basic materials), imported input prices and interest rates (for industrials), and interest and inflation rates (for consumer goods).
Third, we examine the interplay between IMF actions in crisis countries and the actions and responses of local authorities. To do so, not only do we account for the impact of news regarding IMF policy actions but also the government’s reaction to them and willingness to implement such policies, and the public senti- ment about the implemented IMF and government policies. A sig- nificant level of political violence was also observed in Indonesia during the crisis. It included ethnic and religious violence in gen- eral, and the regional violence in East Timor, Aceh, and Irian Jaya, in particular. Besides such violence, political demonstrations, riots, and chaos took place almost on a daily basis and climaxed in the wake of the resignation of President Suharto. As a result, focusing the analysis on Indonesia allows us to learn about investor behav- ior by observing their reaction to IMF assistance in an environment with significant local reaction to IMF actions and political instabil- ity. If IMF assistance is successful especially in such a stressful environment (i.e., government instability and political unrest, as well as an ongoing financial crisis) by restoring investor confi- dence, then the role of IMF in providing an international order may be more important than previously thought.
In this paper we therefore shed some light on the following questions: Do IMF actions and other IMF-related news affect finan- cial and real sector returns differently? During the Asian crisis, the IMF subscribed to restrictive macroeconomic policies in terms of fiscal discipline and higher interest rates while providing liquidity to the financial sectors. Does the IMF turn a financial crisis into a real crisis by advising restrictive monetary and fiscal policies? Among different real sector categories, do some particular real sec- tor returns like consumer goods perform better at the expense of
others such as industrials? 4 To answer these questions we investi- gate market reactions to IMF program announcements comparing stock market returns in financial and real sectors. Previous studies mainly focus only on the impact of IMF actions on financial markets, overlooking how the reaction by the local authorities and the public might affect investor behavior. This is the most comprehensive study focusing on real versus financial sector reactions to IMF policy ac- tions and their implications. 5
Our results can be summarized as follows. First, IMF-related and other type of news have different impacts on different sector returns. Second, IMF policies did not turn a financial crisis into a real one, Third, a negative reaction by the local authorities to IMF
2 See, among others, Sachs (1999), Stiglitz (1999) , and Goodhart and Huang (2005) . 3 For other studies on the causes of the Asian crisis, see Tai (2004), Chancharo-
enchai et al. (2005), Chancharoenchai and Dibooglu (2006) , and Budsayaplakorn et al. (2010) . Kwan (2003) and Agusman et al. (2008) study firm-specific risk factors in several Asian countries during the Asian crisis.
4 We are grateful to an anonymous referee for suggesting this line of motivation,
which sharpened our analysis. 5 In an earlier study, Evrensel and Kutan (2007) study the impact of IMF programs on different sectors but they focus only two types of news (program announcements and negotiations). We focus a larger set of IMF-related news, as well as news related to both the local authorities’ and public’s reactions to IMF news and the political environment of the country.
A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
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A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
policies reversed the initial positive impact of IMF policy actions on act as a proxy for risk. Evrensel and Kutan (2007) examine the im- financial sector returns, suggesting that investors should disregard
pact of IMF news on daily financial sector stock returns in Indone- the possible positive effects of IMF programs if the government is
sia, Korea, and Thailand. They consider two sets of news items, not willing to meet its commitment to agreed IMF programs. An
namely IMF program negotiations and their approval and find sig- important implication of our findings is that the net wealth effect
nificant impact of IMF news on both financial and real sectors. of IMF-related news in private financial markets may be better
Our empirical investigation differs in other ways from many of captured by taking into account the actions of not only the IMF,
the previous studies. First, previous studies mainly consider the but also the reaction of both the local government and the public
impact of IMF programs on asset returns. They do not account towards IMF policy and actions.
for the reaction by the government and the public to IMF policy In the next section, we provide a brief review of the literature.
and actions. In this paper, besides IMF policy news, we also account Section 3 provides a discussion of how we interpret the impact
for news about the underlying situation in the country, local
authorities’ policy reactions to IMF programs, reactions of public nology of key IMF-related events, as well as the other news sur-
of IMF-related news on asset returns. Section 4 discusses the chro-
to the implementation of IMF polices in terms of political unrest rounding the crisis. We discuss our empirical methodology in
and riots, and any other ongoing news that could affect the finan- Section 5 . In Section 6 , we describe our data and provide some
cial markets. Second, previous studies focus on international bank descriptive statistics, while empirical results are discussed in Sec-
stock returns, financial sector returns or composite (aggregate in- tions
7 and 8 . Section 9 concludes the paper. dex) returns but we also include real sector returns. Because IMF actions would also affect returns in real sectors, such as industrial
2. Previous studies and consumer goods, the overall wealth implications of IMF ac- tions for investors may be best captured by studying both financial
There is scant literature on the effects of IMF events on stock and real sectors. If IMF-related news increases financial sectors re- prices. 6 Available literature on stock markets focuses on the
turns, but decreases returns in real sectors, an investor holding response of international bank creditors rather than on local finan-
both assets may end up with a net welfare loss. Third, our study cial companies. Kho and Stulz (2000) examine the impact of IMF
aims at drawing more generalized conclusions on the impact of assistance on the value of bank stocks, both local and international,
IMF-news on the real sectors by expanding the earlier studies that during the Asian financial crisis. They conclude that the IMF pro-
investigate the impact of IMF bailouts on real sectors during other grams have a positive but small effect on international bank values,
crises, such as those in Mexico, Brazil, Korea, and Russia (i.e., Dong while the effect on crisis countries’ banks is insignificant. In a related
et al., 2000 ). Following Kho and Stulz (2000) and Dong et al. (2000) , study, Dong et al. (2000) investigate the impact of the announce-
we use an event-study methodology to capture the wealth effects ment dates of IMF support programs on the abnormal returns of
of IMF actions in both financial and real sectors. In the next section, the US banks during crises in Mexico, Brazil, Korea and Russia, and
we provide some interpretation of events regarding IMF programs they report results similar to those as in Kho and Stulz (2000) in that
and actions in order to develop our hypotheses regarding the im- these banks tend to earn high abnormal returns. Overall, these stud-
pact of IMF actions on asset returns.
ies find that IMF news has a significant positive influence on interna- tional bank returns, but the impact on banks of the crisis countries is either not studied or only briefly mentioned as insignificant.
3. Interpretation of the results regarding IMF assistance and Kutan and Sudjana (2003) 7 examine the impact of IMF-related hypothesis development
news on stock market returns and volatility in Indonesia during the Asian crisis. They find that stock returns react to news about
It is difficult to interpret financial markets’ responses to IMF- requesting loans, negotiations, unfavorable IMF statements, and
related news. If such news increases stock returns, there are two visits by the IMF, while program announcements, loan requests,
conflicting interpretations of this result. One explanation is the and visits bring about a decline in stock market volatility. Hence,
so-called catalytic effect, which suggests that IMF support in terms they conclude that IMF-related news in general do not appear to
of liquidity provides financial stability to crisis countries by create investor panic by raising market volatility.
encouraging private lenders to continue providing liquidity. Other Brealey and Kaplanis (2004) look at a broad sample of IMF pro-
explanation include both debtor and creditor moral hazard ef- grams, other than those implemented during the Asian crisis. They 8 fects. The debtor moral hazard interpretation suggests, due to IMF
also study a wider range of financial assets than those included in support, governments may not implement necessary reforms ad- Kho and Stulz (2000) and Dong et al. (2000) . They find a substantial
vised by the IMF because they are politically costly. The creditor decline in a variety of asset prices in the weeks leading up to the
moral hazard explanation argues that investors would invest more announcement of the IMF programs, but there is no evidence that
on prospective program countries’ assets, because they would expect the announcement of the IMF support caused any part of these
implicit guarantees from the government in case of a loss and this wealth losses to be reversed.
would be paid by using some portion of the IMF support. 9 In addi- Hayo and Kutan (2005) investigate the reaction of composite
tion, some sectors may have close relations to the government and stock market returns and volatility in a diverse group of six emerg-
expect additional liquidity from the government for their risky ing markets to a different set of IMF events, such as delay of loans
investment. Hence, stock market returns would increase when and program approvals. They find that, on average, negative (posi-
investors anticipate a forthcoming IMF program. tive) IMF news reduces (increases) daily stock returns by about one
The event study methodology enables us to distinguish be- percentage point. The most influential single event is the delay of
tween the expectations of investors in different industries. Sectors loans from the IMF, which reduces stock returns by about one
that expect implicit guarantees or additional liquidity from the and a half percentage points. IMF news does not appear to have
government will react positively relative to the market in general.
a significant impact on the volatility of stock markets, which may
8 This section draws on Evrensel and Kutan (2008b) .
See, among others, Lane (1999), Evrensel and Kutan (2008b) and Döbeli and Most studies analyze the effects of IMF-related news with respect to the bond
Vanini (2004) for a discussion on moral hazard.
markets. In this section, we summarize the studies on stock markets. Evrensel and 9 Evrensel and Kutan (2006) develop an IMF-induced creditor moral hazard Kutan (2008a) and Eichengreen et al. (2006) estimate and also provide a review of
framework under alternative assumptions of asset bubbles and implicit guarantees previous studies on the effects of IMF-related news in the bond markets.
and empirically test their model for Indonesian and Korean stock markets.
167 Otherwise market reactions will be neutral or negative in sectors
A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
to cause different effects in financial and real sectors: the govern- that do not expect such guarantees or additional liquidity. To deal
ment provides liquidity support to banks, and nationalizes not only with these conflicting interpretations of IMF actions, following
the banks, but also their debtors, which in most cases, are owned by
the same persons and families. However, IMF policies might still theoretical model developed by Corsetti et al. (2006) who examine
Evrensel and Kutan (2008b) , 10 we rely on the findings of a recent
have a different effect in the real sector as compared to that in the liquidity and moral hazard effects of IMF programs.
financial sector. This is because tight monetary and fiscal policies Corsetti et al. (2006) derive a theoretical model where the cat-
aimed at macroeconomic stability, currency confidence, and finan- alytic effects and moral hazard arguments are evaluated under cer-
cial reform (such as stronger prudential measures) might have larger tain assumptions. 11 They show that large IMF assistance reduces
adverse effects (in terms of higher interest rates and slower credit the probability of a crisis and raises expected gross national prod-
growth) on the real sector than the financial sector. We therefore ex- uct (GNP) by having both direct and indirect positive catalytic ef-
pect that IMF policies have a less favorable impact on the real sector fects. In the case of former, IMF support helps reduce the amount
than the financial sector. Overall, we hypothesize that the liquidity of illiquid investments that need to be liquidated. Regarding indi-
support (and potential implicit guarantees) brings about favorable rect effects, IMF support in terms of liquidity can encourage private
effects on all sector returns. However, in the case of the real sector, investors to retain their funds in the program country. Corsetti
this positive effect is likely to be offset by the negative impact due to et al. (2006) also demonstrate that liquidity support by the IMF
the adverse effects of tight monetary and fiscal policies. Hence, our does not necessarily always induce moral hazard problems.
hypothesis is that IMF programs increase financial sector returns According to their theoretical model, moral hazard takes place only
through liquidity support (and implicit guarantees), but they have when the probability of a speculative run is high. Otherwise,
mixed effects in the real sector, so that returns in the latter might in- liquidity support by the IMF encourages a program country
crease, decline or stay the same, depending upon the net effects of government to have incentives to implement costly policies and
liquidity support and tight policies.
reforms. In this case, we expect an increase in the program coun- try’s real gross domestic product (RGDP) and hence stock returns, which are forward looking, capturing a higher RGDP level in the
4. Event classification and chronology of events future.
Based on the implications of the Corsetti et al. (2006) model, we The task of identifying and classifying IMF-related events poses interpret our findings regarding IMF actions as follows: If returns
significant challenges. Usually there is a sequence of events that in a particular sector are found positive, assuming the probability
leads to the official announcement of a rescue package by the of a speculative run in this sector is not high, this finding is inter-
IMF. The major problem with just focusing on IMF actions is that preted such that liquidity support by the IMF encourages the gov-
during the same period these are not the only events that could af- ernment to implement costly policies and reforms in that sector, 13 fect stock returns. This is a major problem especially in our case
producing higher abnormal stock returns, which reflects a higher because during the crisis period Indonesia had experienced several level of sectoral earnings in the future. On the other hand, if returns
other events such as political unrest, government instability, and sig- in a particular sector are negative, assuming that the probability of
nificant reaction to IMF assistance by the government, as well as by
a speculative run is small, this would imply that a government’s both the public and local people. We therefore categorize the events willingness or effort to implement economic reforms in that sector
in a more comprehensive way than previous studies. In particular, is low and then we would expect a decline in this sector’s future
we define the following event categories: 14 RGDP and hence lower expected stock returns.
Given the above arguments, we can describe our main hypoth- (1) News about the underlying situation. They capture the envi- esis regarding IMF policies as follows: Policies that signal liquidity
ronment prior to the crisis in the country and the govern- or inject direct liquidity increase both financial and real sector re-
ment’s request to ask for help from the IMF. turns, while those IMF policies that signal that IMF may stop inject-
(2) News about the IMF’s policy reaction. They summarize how ing liquidity to the crisis country, which may be due to the
the IMF reacts to the crisis and the request for assistance opposition of the local government to her policies, the lack of sup-
from Indonesia, as well as program approvals and conditions port by the public regarding IMF actions, or political uncertainty,
imposed on the government to keep receiving IMF reduces asset returns. There are grounds to believe that the effect
assistance.
of IMF support will be similar in both the financial and real sectors, (3) News about the local authorities’ policy reaction. They show especially in a highly-linked economy as Indonesia was in the
how the local authorities, including government and key 1990s, where the top 15 business families are estimated to own
governmental organizations, react to IMF’s assistance and some 62% of the corporate sector across different business lines
conditions.
( Claessens and Djankov, 1999 ). In addition, in terms of moral haz- (4) Reaction by the public and companies to local authorities’ ard and implicit guarantees issues, there is sufficient evidence that
polices following IMF help/agreements, including political
all sectors had implicit guarantees during the crisis. 12 Implicit guar-
unrest, riots, etc.
antees during the crisis target both sectors and therefore are unlikely (5) Other ongoing news during the crisis period that might
affect the financial markets.
10 Evrensel and Kutan (2008b) use the Corsetti et al. (2006) model to interpret the We present the details of IMF-related events in Table 1 . impact of IMF programs on the forward foreign exchange market in Indonesia.
Column 1 presents the actual calendar date of the event, while 11 For space considerations, we do not discuss the Corsetti et al. (2006) model in column 2 presents the event descriptions. In column 3, we give
detail here. Corsetti et al. (2006) and Evrensel and Kutan (2008b) provide detailed event classifications as above. In addition, in column 4, we further discussions. 12
Kane and Klingebiel (2004) argue that there was a significant amount of liquidity support to insolvent institutions during the crisis period and afterwards that is
13 Cornel and Shapiro (1986) for example could not identify days with significant equivalent to 17% of GDP. In addition, there was a blanket government guarantee
impact during the 1980 debt crisis. Kaminsky and Schmukler (1999) , on the other issued in January 1998 covering all bank commitments with no losses imposed on
hand, start with days with high returns and find that agreements with international depositors. Rokhim (2005) shows that many conglomerates had banks and related
organizations are usually contemporaneous with them. lending taking place through firm affiliations with banks and these conglomerates
14 We are grateful to an anonymous referee for guiding us in categorizing events in were in both financial and real sectors.
this fashion, which greatly improved the presentation and the quality of the paper.
A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
Table 1 Indonesia news. Sources: Kho and Stulz (2000) . The Wall Street Journal, Asian Wall Street Journal, CNN, BBC, Bisnis Indonesia, the IMF Independent Evaluation Office (2003), New York Times, LA Times.
Date News Event Good/ type
bad news
1997 14-August
Indonesia free floats currency exchange rate 5 Good 29-August
BI Governor announces limits on forward foreign currency trading by domestic banks 5 Good 3-September
Reform measures introduced 5 Good 4-September
Indonesia cuts rate on notes 5 Good 17-September
Indonesia slashes government outlays 5 Good 8-October
The government requested assistance from the IMF and the World Bank 1 Good 29-October
Indonesia discloses Singapore aid plan, confusing officials and investors alike 5 Bad 31-October
2 Good financial support package 1-November
Indonesia issues a Letter of Intent and Memorandum of Economic and Financial Policies; IMF gives Indonesia a USD 23 billion
The government closes 16 banks. Guarantees payment of up to IDR 20 million per deposit starting November 13 3 Good 3-November
The rupiah strengthens by 7% following intervention by monetary authorities of Indonesia, Singapore, and Japan 3 Good 5-November
Bank Andromeda, partly-owned by President Suharto’s son, files lawsuit against Minister of Finance and Bank of Indonesia Governor, 4 Bad challenging bank closure 7-November
In Switch, Indonesia Lets 15 Big Projects Proceed 5 Bad 11-November
IMF Managing Director visits Jakarta 2 Bad 23-November
The President’s son buys a small bank and starts business on the premises of Bank Andromeda 5 Bad 25-November
IMF mission arrives in Jakarta 2 Bad 5-December
President Suharto begins 10-day rest at home 5 Bad 12-December
President Suharto cancels plan to attend ASEAN summit in Kuala Lumpur 5 Bad 30-December
Jakarta court decides to delay the liquidation of PT Bank Jakarta owned by President Suharto’s half brother, Probosutedjo 4 Bad 1998
6-January President Suharto announces 32% increase in government spending for 1998/1999, perceived as violating IMF targets 3 Bad 9-January
US President Bill Clinton calls President Suharto to insist that IMF program must be followed 5 Good 11-January
Opposition chief calls on President to resign (5) 5 Bad 12-January
Muslim leader tells Suharto to go 5 Bad 13-January
The IMF and Indonesia appear to be near an agreement over the IMF bailout; the government is reported to be considering 1 Good introducing a currency board 15-January
Indonesia issues the Memorandum of Economic and Financial Policies (never approved) 1 Good 16-January
Indonesia pact with IMF fails to halt unrest; currency falls again; food price riots erupt 4 Bad 19-January
President Suharto emphasizes that National Car Project and plan to develop Indonesian jet plane will continue without state funding 5 Good or assistance 27-January
3 Good 28-January
Government announces full guarantee of commercial bank deposits and credits and new agency to restructure banking sector
Partial halt by Indonesia on payments 1 Bad 11-February
Indonesia will peg rupiah to the dollar (currency board) 1 Bad 12-February
Indonesia cracks down as protests hit capital. Food riots have broken in a score of communities around the country 4 Bad 12-February
Suharto replaces central bank governor 5 Bad 14-February
One dead as price riots escalate in Indonesia towns (2/13–2/16) 4 Bad 16-February
The IMF disagrees with Indonesia about adopting a currency board 2 Bad 17-February
2 Bad 20-February
The IMF has threatened to withhold further money under a USD 43 billion bailout package if Indonesia adopts a currency board
Indonesia will repay deposits at closed banks 3 Good 9-March
A simmering dispute between the IMF and Indonesia 1 Bad 10-March
Indonesia’s Suharto re-elected, names VP choice 5 Bad 11-March
Indonesia considers a currency board, as dollar is held within narrow range. Students stage protests 1 Bad 21-March
The IMF and the Indonesian government have made ‘‘considerable progress’’ toward a new deal; Indonesia ends controversial
2 Good
currency plan; IMF official says country is also making progress on revising agreement with the agency that will lead to economic reforms
23-March Indonesia raises interest rate 3 Good 26-March
1 Good decades, which Indonesia has agreed to in exchange for a USD 40 billion bailout 6-April
Indonesia said that it is close to a comprehensive package of measures to lift the country out of its worst economic crisis in three
Indonesia makes move on 14 banks 3 Good 8-April
Indonesia said that it had reached agreement with the IMF on a new package of economic reforms and targets, which the IMF would 2 Good watch closely to ensure compliance 10-April
Indonesia issues a Supplementary Memorandum of Economic and Financial Policies on additional measures 1 Good 13-April
Suharto seeks to dispel reform doubts 3 Good 5-May
Indonesia sharply raises energy cost 3 Good 7-May
6 Dead as riots rock Indonesia for 3rd day 4 Bad 8-May
Riots in Indonesia’s third largest city 4 Bad 9-May
Anti-Suharto protests continue at colleges 4 Bad 14-May
4 Bad following days, May 13–14 15-May
Suharto returns to war zone. At Jakarta’s Trisakti University six students died on Tuesday May 12, sparking riots and protest the
Indonesia lurches towards anarchy 4 Bad 21-May
President Suharto announces his resignation and immediately hands power over to Vice President B.J. Habibie 4 Good 4-June
5 Good Restructuring Agency (INDRA) 17-June
Indonesia and creditors agree on a comprehensive program to address external debt, including creation of an Indonesian Debt
Indonesia protesters demand lower food prices, vote on East Timor 4 Good 18-June
The Export–Import Bank of Japan announces that Japan signed USD 1billion trade credit facility for Indonesia 1 Good 24-June
Government signs fourth agreement with IMF 2 Good 2-Jul
Indonesian Debt Restructuring Agency (INDRA) established 5 Good 8-Jul
Protests, violence continue in Indonesia 4 Bad 1-September
Riot erupts in Indonesia 4 Bad
169 Table 1 (continued)
A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
Date News Event Good/ type
bad news
10-September Students intensify protests in Indonesia 4 Bad 14-September
Rioting erupts in Indonesia’s third largest city 4 Bad 16-September
Food riots stretch into second week 4 Bad 23-September
Paris Club reschedules USD 4.2 billion of sovereign debt 5 Good Event types: (1) News about the underlying situation (crisis in the country asking for help from IMF etc.). (2) News about the IMF’s policy reaction (how IMF reacts to the crisis
and the request from assistance from Indonesia). (3) News about the local authorities’ policy reaction (how the local authorities – including government and key govern- mental organizations – react to IMF’s policies). (4) Reaction by the public and companies to local authorities polices following IMF help/agreements (political unrest, riots, etc.). (5) Other ongoing news that might affect the financial markets.
classify the news into either good news or bad news to see how sector, including closing unviable banks. Third, a broad range of such asymmetric news in general affects the market sentiment
structural reforms will be implemented, including liberalization and hence returns, in both financial and real sectors. Arguably,
of foreign trade and investment, dismantling of domestic monopo- the designation of good and bad news is subjective. In this study,
lies, allowing greater private sector participation in the provision we classify news as good if it affects market sentiment positively.
of infrastructure, and expanding the privatization program’’ (IMF This includes news of IMF program approvals and news about gov-
Press Release, November 5, 1997). 15 The program had the objectives ernment actions that are in line with IMF provisions. We classify
of restoring market confidence by maintaining prudent macroeco- bad news as those that would adversely affect market confidence,
nomic policies, addressing weaknesses in the financial sector, includ- which include announcements of government policy that run
ing the closure of 16 banks; and undertaking structural reforms to against its commitments to IMF programs and political instability
improve economic efficiency. On the first trading day after the arising from unfavorable IMF policy actions. Announcements of
announcement of the program on October 31, 1997 stock returns de- IMF policies may not be as clear cut, however. This is because the market might view the adoption of IMF programs not only as
the reaction in real sectors was much milder in general and positive
a positive signal, but also as a sign of economic frailty or the gov- with a 4.42% increase in Basic Materials in particular. ernment’s incapacity to tackle the crisis.
There was no significant political event taking place on the date In the past, the government of Indonesia has managed to use its
of the announcement, nor immediately after, and the market access to multilateral financial organizations, such as the IMF, in a
responded positively in the first couple of days after the announce- credible way. Thus, there was no hesitation to use this access, pub-
ment. The day after the announcement of the IMF agreement, the licly, once more. Such a step was deemed to be able to stem the
government closed 16 banks and the rupiah improved in the next panic. This was different from the Korean case, whose government
couple of days. However, on November 5, 1997, a bank partly contacted the IMF in secret, with the assumption that such news
owned by a son of the President filed a lawsuit against the Finance would give the impression that the government was not in control
Minister and the central bank Governor. Stock returns fell in all of the situation. The 1997–1998 crisis in Indonesia was influenced
sectors. On November 7, 1997, the government reversed its deci- by political developments in the country as well. Agreement with
sion to halt 15 large infrastructure projects. Stock returns contin- the IMF was struck four times within several months. What char- acterized these agreements was the almost immediate reversal of
visit by the IMF Managing Director on November 11, to which position by the Indonesian government right after signing the
the investors react positively by increases of 4.39% in Industrials agreements. In chronological order, we summarize these programs
and 2.10% in Banking, the President’s son bought a small bank on below and also discuss the underlying news related to each pro-
November 23 and began operations on the premises of his old gram. As we discuss the news in chronological order, we also pres- ent the raw stock returns in Indonesia during the critical event days to see how markets react to crisis-related events. These raw
On December 30, 1997, the Jakarta court decided to delay the returns are reported in Table 2 . Details of the definitions of event
liquidation of another bank owned by the President’s half brother
dates are given in Section 5 .
( IMF/IEO, 2003 ). Real sectors reacted positively with Basic Materi- als increasing by 5.81% and Consumer Goods increasing by 3.50%.
4.1. The November 1997 IMF program The government’s position was neither unified nor firm. The eco- nomic ministers, who are in favor of the IMF program, were under-
In September 1997, with the continuing decline of the rupiah, mined by the President and his relatives, whose interests were in the government of Indonesia notified the IMF that it might need
danger of being swept aside by the IMF program.
a ‘precautionary’ arrangement. On October 8, 1997 when the gov- ernment requested help from the IMF, stock returns increase by
4.2. The January 1998 IMF program
4.79% in Financials and 3.95% in Banks, while real sectors have much milder reactions ( Table 2 ). Subsequently IMF missions vis-
In November and December 1997, the political dimension of the ited the country in October. The first agreement was announced
crisis began to appear. Ethnic and food riots took place more often. on October 31, 1997 and signed in November. According to this
The President fell sick in early December and this raised questions agreement, key policies to be implemented included the following:
about succession. The IMF drew up another agreement with a de- ‘‘First, the authorities will maintain tight fiscal and monetary pol-
tailed structural reform agenda, accommodating the opinion of the icies, designed to stabilize financial conditions and narrow the cur-
government that extensive structural reform was needed. The IMF rent account deficit. Substantial fiscal measures have been put in
Managing Director attended the January 15 signing of the program. place to keep the budget in surplus, despite the cyclical downturn,
On the day, stock returns increased by 25.45% in the Banking sector while monetary policy will be kept tight. Second, prompt, and deci- sive action will be taken to restore the health of the financial
15 See http://www.imf.org/external/np/s/pr/1997/pr9750.htm .
A.M. Kutan et al. / Journal of Banking & Finance 36 (2012) 164–182
and 19.05% in Financials. Basic Materials responded most among The raw returns presented here do not have any statistical sup- the real sectors, up 10.36%, and returns in Consumer Goods and
port and hence may not capture the true wealth effect reflected in Industrials rose 2.65% and 1.57%, respectively. The program
cumulative abnormal returns. To deal with this issue, we use an included provisions to cancel 12 infrastructure projects, cancel-
event-study methodology. In the next section we first explain the ation of privileges for the National Car Project owned by the
methodology.
President’s son, elimination of the state agricultural products dis- tribution monopoly, and elimination of the clove marketing monopoly, also owned by the President’s son. However, the
5. Methodological issues
program was never presented to the IMF Executive Board because revised budget targets became immediately irrelevant due to the
We investigate the extent to which IMF-related announcements rapid depreciation of the rupiah ( IMF/IEO, 2003 ).
have an effect on asset values, using the standard event-study The next day, on January 16, the rupiah was reported to take
methodology commonly used in finance. Stock returns contain another plunge as food riots were reported. On January 27, the
expectations of investors about future economic activity when government announced a blanket guarantee on commercial banks.
market participants learn about IMF related announcements. Event Stock returns rose 7.44% in Banks and 9.81% in Financials. Con-
studies are based on the presumption that the market impounds all sumer Goods were up 8.04% while Basic Materials and Industrials
new information in stock prices immediately. The return to a coun- were up 1.47% and 2.92%, respectively. On February 12, the Presi-
try’s stock market provides a forward-looking measure of changes dent replaced the finance minister and the government indicated
in expected future economic activity ( Kho and Stulz, 2000 ). Follow- that it would opt for a currency board arrangement. The financial
ing these studies, we account for shocks to aggregate economic activity through each sector’s exposure to the stock market and
reacted positively with a rise of 7.68% in Basic Materials, 1.67% in use the abnormal returns (AR). In order to understand whether Industrials, and 1.54% in Consumer Goods.
there is something unique to each sector’s exposure to events re- News of food riots continued to be reported during the months
lated to IMF actions during the crisis we need to account for the of February and March, while the government and the IMF dis-
impact of news/shocks on aggregate economic activity in each sec- agreed on the currency board issue. On March 10, 1998, the Presi-
tor. Since stock prices are forward looking, we have to consider dent was re-elected. The real sector reacted positively with a 5.16%
changes in expected future economic activity in each sector when increase in Industrials and a 2.46% increase in Basic Materials while
market participants learn about them. A systemic risk should affect financials and banks increased by 1.86% and 1.08%, respectively. On
all firms in all sectors. We therefore account for shocks to a specific March 21, under pressure from the IMF and other countries, the
sector through the exposure of that particular sector to the stock currency board option was dropped. Returns were down by
market and use abnormal returns. For example, Kaminsky and Schmukler (1999) and Evrensel and Kutan (2007) use returns on specific days of the Asian crisis for their analysis. In contrast, we
the re-election the President seemed supportive of the IMF pro- use each sector’s ARs, which are measured in excess of the market, gram and the government worked toward another agreement with
and thus cannot be predicted on the evolution of the stock market the IMF.
during the crisis. Hence, if asset values fall, for example, in the banking sector only because the stock market falls, the AR is zero
4.3. The April 1998 program irrespective of why the stock market falls. If that were the case, a fall in the stock market brought about by IMF-related news could
On April 8, a new agreement was announced. In the April agree- lead to a fall in bank values but there would be nothing specific ment, the fiscal position was relaxed, allowing a deficit of 4.7% of
to the banking sector about the impact of IMF-related news on GDP. Interest rates also rose sharply. The program also included
bank values. Therefore, our methodology is designed to differenti- the elimination of subsidies on agricultural products, privatization
ate the impact of IMF-related news that is unique to banks as op- of state-owned enterprises, and the lifting of restrictions on foreign
posed to the impact they have on the whole economy. Accordingly, investment. The real sectors reacted most with a fall of 4.16% in
we investigate ARs in each sector in excess of the market returns industrials accompanied by increases of 1.84% in Basic Materials.
on important dates of the crisis.
The President then took a step to increase fuel prices on May 5. Ini- When using the event study methodology, the initial task is to tial reactions were mixed with returns increasing by 13.34% in
identify the events and the event window, the period over which stock prices are examined. In our case we define an event as the ar-
gered demonstrations and protests on the same day and until May rival of news related to the crisis in Indonesia. This is a difficult and
9. On May 12, demonstrators at a university in Jakarta were fired manual job. As described in the data section below we use a num- upon, resulting in civilian casualties. Protests on May 13 and 14
ber of data sources and hand collect the events. Choice of the event soon turned into riots, which lasted for almost 2 weeks, culminat-
window entails some arbitrariness in a study like this ( Kho and ing in the resignation of the President on May 21. Market reaction
Stulz, 2000 ). One difficulty with defining the event window is that was positive in all sectors. Returns were up by 2.99% in banks and
it is not always clear when an event takes place. As we describe in 6.60% in financials. In all real sectors prices were up; by 6.02% in
detail in the data section we take into account the time differences; Basic Materials, 3.14% in Industrials, and 4.53% in Consumer Goods.
for example, an event taking place in the US on day t gets incorpo- This marked a breaking point during the crisis. The new President,
rated into prices in Indonesia on day t + 1. Still we do not know the Habibie, prioritized economic stabilization and rescheduling of
intraday timing of the announcements. Therefore we use a conser- public debt. The IMF and the government negotiated a new