Financial Sector Reforms and Currency Crisis: The Indonesian Experience

The theory of exchange rate determination clearly links a depreciating currency to a deteriorating trade balance, interest differential and related economic fundamentals. Empirical testing carried out routinely confirms these relationships in “normal†times as currencies constantly align themselves to find their places in the global marketplace. When depreciation reaches crisis proportions, they are not always caused by a proportional deterioration in economic fundamentals. Random activities like speculative attacks are prompted by perceived problems in the banking sector as well as the contagion effect, leading to a currency crisis. Using pre crisis data and focusing on the Indonesian rupiah, this view is confirmed in the research.