INTRODUCTION

Amid the global financial turbulence, the economy of Indonesia posted an annual average growth of above 6 per cent between 2008 and 2012, except in 2009. This was arguably among the most stable growth performance among the regional economies of East and Southeast Asia. The strength of domestic demand has indeed been a primary driver of the stable growth performance. In contrast to the major ASEAN (Association of Southeast Asian Nations) economies, exports of Indonesia amounted to less than 25 per cent of its GDP, compared to Malaysia at more than 80 per cent and Thailand at more than 60 per cent in recent years. Private consumption contributed between 44 and 49 per cent of the quarterly year-on-year GDP growth in 2012 (see Figure 2.1). Indonesia has also seen investment pick up in recent years, and the country's resilient growth in 2008–12 can also be attributed to high commodity prices and capital inflow surges.

Despite the large domestic demand base, the uncertainties with the advanced economies, particularly the United States and the European Union, had negatively affected and exposed a number of apparent weaknesses with the Indonesian economy. A couple of these vulnerabilities are worth highlighting as they are arguably structural in nature. First is the country's banking sector's exposure to cross-border bank-lending activities. Like the rest of the ASEAN economies, the banking sector assumes a vital role in overall financing activity in the local economy. Among the major ASEAN economies, Indonesia arguably adopts the most open banking sector regulation. Majority foreign ownership, as high as 100 per cent, has long been adopted following the 1997 East Asian crisis. Furthermore, foreign banks are allowed to enter the local industry both as a branch or a subsidiary. The high interconnectedness of the local banking sector to the global banks exposed the local economy to increasingly volatile cross-border bank-lending flows as evident during the deleveraging of the European banks in 2011.

The second is current account weaknesses. The persistent current account deficits in recent years have raised concerns over macroeconomic stability, causing depreciation pressures on the local currency. The root cause of the current account deficit has been attributed to costly long-standing energy subsidies and the heavy reliance on commodity exports.