The Importance of Financial Liberalisation to Economic Growth: The Case of Indonesia

Indonesia has been struggling to return to its pre-Asian Financial Crisis growth level. The government, realising the needs for external finance, is trying to formulate more liberalised investment policies, both on the portfolio investment and direct investment, while also controlling the risk premia that may be associated with financial liberalisation. This paper examines the mechanisms afforded by the policies to, among other things, improve access to finance and encourage productivity growth through more effective matching of labour and capital, as well as attaining global best practices. The potential gains to the Indonesian economy are illustrated using a version of the GTAP model extended to model possible changes in the cost of capital in the standard version of the model. The results provide an indication of the substantial potential economic benefits that could accrue to the Indonesian economy, if the government let a potentially short-term trade deficit.

Bulletin of Indonesian Economic Studies