Capital controls may become a boomerang<\/p>\n
By Eddy Soeparno<\/p>\n
JAKARTA (JP): As expected by many analysts, the government
\nrecently announced that it would study Chile's treatment of
\nshort-term fund flows as well the possibility of requiring
\nexporters to surrender their dollar earnings.<\/p>\n
The flows of \"hot money\" -- a terminology used to describe
\nfast-moving institutional capital -- has been widely blamed for
\nmuch of the financial and economic chaos Indonesia and the rest
\nof Asia are now experiencing. As such, there has been a growing
\ninterest among economists and policymakers around the globe to
\nimplement measures that would clamp down on these types of short-
\nterm and speculative capital flows.<\/p>\n
In a world of almost nonexistent financial borders, capital
\nmoves in and out of countries and fast-moving industries make
\nill-prepared economies vulnerable to such movements.<\/p>\n
Malaysia realized this fact and as a result, imposed strict if
\nnot controversial controls limiting cross-border investments and
\ncurrency conversions on Sept. 1. One month after imposing such
\ncontrols, Malaysia's special economic minister, Daim Zainuddin,
\nrecently spoke about the success of the policy: \"The currency is
\nstable, banks have started lending, the private sector is now
\nborrowing and economic activity is picking up.\"<\/p>\n
What he failed to mention though, was the additional risk the
\nbanking sector must take by recognizing nonperforming loans after
\nnot being serviced for six months as compared to three months
\npreviously. Moreover, liquidity is being forced back into the
\nmarket by cutting reserve requirements from 4 percent to 2
\npercent, while banks are strongly encouraged to grow their loan
\nportfolio at an annual 8 percent growth rate (which will
\neventually trigger unnecessary expansions in industries already
\nsuffering from a severe lack of consumer demand).<\/p>\n
Most importantly, in an environment where a currency is fixed
\nand considerable sums of liquidity enter the market, prices of
\ngoods and services can go nowhere but up, fueling further
\ninflation.<\/p>\n
Now to Indonesia and its capital control intentions. The
\nquestion is: How would these measures work for Indonesia?<\/p>\n
When Chile suffered from a similar financial crisis in 1982,
\nit decided to discourage inflows of foreign capital, despite
\nbeing a robust supporter of the United States free market
\ndoctrine. All loans and bank deposits were in effect taxed, as 30
\npercent of a loan had to be deposited in a non-interest bearing
\naccount at the central bank.<\/p>\n
Although the controls proved to be effective for a while in
\nbringing down the overall level of short term capital and further
\nencouraged long-term investment, subsequent studies have
\nindicated that the impact of the controls may have been smaller
\nthan previously anticipated.<\/p>\n
Chilean economist Marcelo Soto concluded in his analysis that
\neven though the corporate sector may have reduced foreign short-
\nterm borrowings, other short-term flows increased (including
\nindirect foreign borrowings). Thus total short-term flows were
\nnot reduced. It now remains in the hands of Indonesian whether to
\ncompletely control the flow of foreign capital or limit its
\ncontrol to foreign borrowings only.<\/p>\n
Noting that Indonesian corporations are well over-leveraged by
\ntheir current debt, curbing the inflow of short-term money would
\nnot be a bad idea after all. In addition, more options could also
\nbe studied by taking examples from other countries, such as
\nBrazil which at one point levied a 1 percent tax on foreign
\ninvestment in its stock market to discourage short-term trading.<\/p>\n
In addition, Mexico temporarily restricted bank foreign-
\ncurrency liabilities to 10 percent of their total loans, while
\nthe Czech Republic imposed a fee on all foreign-exchange
\ntransactions with banks.<\/p>\n
Furthermore, the possibility of forcing exporters to
\nrepatriate their export earnings in an attempt to regain badly
\nneeded foreign exchange (to help stabilize the rupiah), could
\nalso pose a problem of its own -- an incentive problem.<\/p>\n
Over the past year now, Indonesian exporters basically parked
\ntheir foreign exchange revenues in offshore accounts in reaction
\nto rumors of a possible government-imposed deposit-to-bond
\nconversion and because of difficulties in withdrawing foreign
\nexchange from local banks on request.<\/p>\n
As such, requiring exporters to surrender their foreign
\nexchange earnings without any guarantees of freely converting or
\nwithdrawing their money would only encourage the exporters to
\nfind loopholes in the regulation, such as by under-invoicing
\nexports.<\/p>\n
An Indonesian company could, for instance, export its goods to
\na subsidiary in Singapore or Hong Kong for a minimum price. The
\nproduct could then be on-sold to the final buyer at its actual
\nmarket price, thereby allowing a significant amount of the
\nforeign exchange export margins to be kept safely in offshore
\naccounts.<\/p>\n
Obviously, monitoring the proposed foreign exchange
\nrepatriation scheme would require significant bureaucratic
\nsupport, which would be costly but not necessarily efficient.
\nMoreover, bureaucracies are normally no match for determined
\ncapital exporters and such a bureaucratic system for the scheme
\ncould well be the cause of new forms of corruption and collusion.<\/p>\n
Actually, what Indonesia should realize today is the fact that
\nits problems lie in the political arena along with erroneous
\nmonetary policies and weak measures to overcome the mounting debt
\nproblem. Therefore, aside from the political situation, the
\ngovernment should focus on bringing down interest rates and
\nsuccessfully restructuring the country's debt -- all addressable
\neven without the implementation of strict capital controls.<\/p>\n
At present, Jakarta should see the role of capital controls as
\na \"confidence gainer\" rather than a \"problem solver\".<\/p>\n
Let lower interest rates and the settlement of the foreign
\ndebt be the answer to the country's economic predicament. Capital
\ncontrols, though, could be used over the short term to avoid
\nfuture financial chaos.<\/p>\n
As for export-related revenue, the only way to push local
\nbusinesses to repatriate their foreign exchange earnings into the
\ncountry is by giving them some form of incentive; and economic
\nstability will most likely do the job.<\/p>\n
Although the introduction of the above proposed \"limited
\ncapital controls\" could very likely discourage short-term money
\nflows into Indonesia, as well as harvest direly needed foreign
\nexchange, local and foreign investor confidence should be
\nprioritized.<\/p>\n
The country now needs to focus on regaining market confidence.
\nImposing any form of strict capital controls could risk putting
\noff a great number of investors and creditors.<\/p>\n
Therefore, unnecessary or excessive curbs on the movement of
\ncapital could backfire on the government and result in another
\nstampede of fleeing investors. Malaysia is a perfect example
\nwhich should discourage Indonesia from implementing a \"Hotel
\nCalifornia\" type of control, where \"you can check in any time you
\nwant, but you can never leave...\"<\/p>\n
The writer is a corporate finance director at American Express
\nBank.<\/p>\n
Window: The country now needs to focus on regaining market
\nconfidence. Imposing any form of strict capital controls could
\nrisk putting off a great number of investors and creditors.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/capital-controls-may-become-a-boomerang-1447893297",
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"sponsor": "Okusi Associates",
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