Beefing up reserves

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.