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

Indonesia has been struggling to return to the levels of economic growth it achieved before the Asian financial crisis. The government has been working on more liberal investment policies to attract external finance, both through portfolio investment and direct investment, while also trying to control the risk premia that may be associated with financial liberalisation. This article examines the mechanisms of the policies to, among other things, improve access to finance and encourage productivity growth through more effective matching of capital with labour, as well as the use of global best practices. The potential gains for the Indonesian economy are shown using an extension of the Global Trade Analysis Project (GTAP) model that covers possible changes in the cost of capital. The results indicate that the Indonesian economy could benefit substantially if the government allows a short-term trade deficit.