IMF-Related Announcements, Fundamentals, and Creditor Moral Hazard: A Case Study of Indonesia

Previous tests of creditor moral hazard cannot distinguish between two types of investor behavior: expectations of implicit guarantees or better future economic fundamentals due to a prospective IMF program. The novelty of our approach lies in the inclusion of the forward foreign exchange rate in the empirical tests of creditor moral hazard, which reflects investors’ expectations about the country’s future fundamentals and allows us to separate the effects of fundamentals from those of moral hazard. Using Indonesian financial markets as a case study, we first conduct tests of creditor moral hazard in the Indonesian bond and stock markets. Then, we use the forward exchange rate to confirm the interpretation of the bond and stock market results. Our results show that IMF-program related news, especially, the announcement of program negotiations, brings about higher stock returns and lower bond spreads, even though the bath sells at a forward discount on the same day. These results suggest creditor moral hazard in the Indonesian bond and equity markets.