Beefing up reserves

We should not read too much into the new borrowing made by Bank Indonesia from a syndication of 40 international banks yesterday. The new loan of US$500 million will serve only as a standby financial facility which the central bank can draw immediately in case of an urgent need to ward off currency speculations.

The new loan, as Bank Indonesia's Governor Soedradjad Djiwandono said, was secured to maintain the level of the standby facility at $2 billion because $500 million of the existing facility had matured. As its name denotes, the loan will not be used but will serve only as a standby to beef up Bank Indonesia's foreign reserves. Since the loan is not disbursed the central bank is required only to pay a commitment fee.

But the commitment fee is by no means a waste of foreign exchange. It should be seen as part of the costs of maintaining monetary stability. The standby facility, combined with the almost $20 billion in foreign reserves (equivalent to about five months of imports)held by Bank Indonesia, will serve as a deterrent to currency speculation.

As Indonesia pursues an open capital account and its financial market becomes increasingly intertwined with the international market, the country may occasionally encounter a wave of currency speculations. This may be due to wild rumors or a fallout from financial crises in other countries such as the one which hit Indonesia in early 1995 following the financial crisis in Mexico in late 1994.

A relatively large amount of foreign reserves is also needed, especially now when Indonesia is suffering a big deficit in its current account (balance of trade in merchandise and services). The deficit, at about 4 percent of its gross domestic product, is still much lower than the 8 percent suffered by Thailand and Malaysia. But Indonesia's position is more precarious due to its huge foreign debts of nearly $100 billion.

However, the standby loan and the high level of foreign reserves are not effective alone in maintaining monetary stability and managing the balance of payments. Private capital flows -- portfolio and foreign direct investment -- should continue to prevent the current account deficit from worsening.

In this context, it is worth recalling the latest annual report of the World Bank on private capital flows to developing countries. The report, which was issued Monday, strengthened the message that "if you want to woo more private investment, you should make your economic fundamentals sound and macroeconomic management prudent".

The Global Development Finance, the successor publication to the World Bank's World Debt Tables report, showed a 33 percent increase in private capital flows to developing countries in 1996. Although all developing regions saw increases in capital flows, 73 percent of the $243.8 billion private capital flows last year went to just 12 of the 108 developing countries (low and lower middle income). Among them was Indonesia which ranked the fifth largest recipient with almost $18 billion after China, Mexico, Brazil and Malaysia.

These 12 countries, including Thailand, Argentina, India, Russia, Turkey, Chile and Hungary, have gained better access to the international capital markets because of their sound macroeconomic management, stronger financial institutions, more transparent legal and regulatory structures and greater receptiveness to private financing for infrastructure.

This trend indicates that investors are increasingly shrewd and better able to differentiate between developing countries on the basis of their economic potential, stability and credit profile.

The report records increases in all categories of private capital flows -- portfolio investment (bonds and equities), credits and foreign direct investment. The rise in portfolio capital flows from $32.1 billion in 1995 to $45.7 billion in 1996 was attributed largely to the eagerness of investors to diversify their investment to seek higher profits in the dynamic emerging markets. The surge in credits to $88.6 billion was caused by project financing in infrastructure.

The 14.6 percent expansion in foreign direct investments to $109.5 billion was especially encouraging because direct investment by companies also brings in technology and managerial knowledge to the host countries. The direct investment flows indicate that long-term foreign investment both depends on, and in turn prompts, better economic policies and market liberalization.