Suppose Indonesian banks have borrowed heavily in foreign markets and have lent to domestic construction companies. If the Indonesian rupiah devalues strongly,

Question

Suppose Indonesian banks have borrowed heavily in foreign markets and have lent to domestic construction companies. If the Indonesian rupiah devalues strongly, the banks will not be able to pay back their foreign debts. Global investment bankers become concerned about that possibility and stop lending to Indonesia. To assure the creditors, Indonesia’s central bank issues a statement indicating that it would provide cash rupiahs to the banks in trouble in case of a large devaluation to prevent them from failing. Should the global investment bankers be reassured by this statement or not? Why? Please explain your answer.

Answer 1

Foreign lenders do not want cash Rupiahs. They will be worthless or at least worth less. If the central bank said they would pledge their FX reserves to support the banks it would be a (slightly) different story.