BI in the amended Constitution: Never repeat same mistake

BI in the amended Constitution: Never repeat same mistake

Umar Juoro, Economist, Jakarta, juoro@indo.net.id

To meet the demands of reform, the People's Consultative
Assembly (MPR) have amended the 1945 Constitution. Subsequent to
the first, second and third phase of amendments, a number of
articles are going through amendments in the current fourth
phase, which includes the role of Indonesia's Central Bank (BI).

In the formulations proposed there are several alternatives.

The first is that monetary policies should be the
responsibility of an independent central bank. The second
alternative says that a separate monetary authority should take
care of such policies. The third one is similar to the first,
except the word "independent" is not used.

Based on Indonesia's and other countries' experience, when a
central bank is politically coopted, its function in implementing
monetary policies and supervision of banks is very much impaired.

During the New Order period, apart from being burdened with
many duties - monetary policies, supervision of banks, payment
system and boosting the country's development - it often had to
bow down to the wishes of the government, or the president, to be
more accurate, who often wielded his power directly or indirectly
through the minister of finance.

If the Central Bank had been not "too close" to the
government, some of its controversial policies - such as Central
Bank Liquidity Support (BLBI), full guarantee for third parties'
funds in the problematic banks - could have been not so damaging.
During that time the Central Bank was obeying the government's
wishes, though internally it had its own shortcomings as well.

To avoid past mistakes and to let the Central Bank fully
concentrate on monetary policies, especially those related to
exchange values and inflation, the demands for its independent
role have grown stronger. Hence the issuance of Law no. 23/1999
to make it an independent institution to implement the required
monetary policies.

However due to the pro and contra situation during the
implementation of this law, it was deemed necessary to make an
amendment to the constitution.

Furthermore, during the tenure of former president Abdurrahman
Wahid, there was a strong desire to change the governor of the
Central Bank. In spite of this, most of the legislators involved
in the amendment realized the importance of an independent
central bank to create a more stable economy for the country.
Only an amendment to the Constitution - rather than laws which
can be easily changed to suit the wishes of anyone in power - can
strengthen and confirm the central bank's independent position.

The second alternative suggested for the amendment in regard
to a separate monetary body reminds us of the Currency Board
System (CBS), which was planned during the era of former
president Soeharto at the beginning of the country's economic
crisis in 1998. The plan was aborted as it was considered
unsuitable for Indonesia's economic condition. The country's
foreign currency reserve was not sufficient to make such a plan
workable. What made it less feasible was the fact that
Indonesia's economy was closely linked to that of United States,
because the rupiah was to be pegged to the dollar at a certain
value.

Another implication is that the rupiah currency would become
less flexible in facilitating exporters' competitive edge.
Besides, there could be a serious disparity in earnings because
most of the community would enjoy less access to formal monetary
realm as the amount of money in circulation became more limited
as it was brought in proportion to the availability of foreign
exchange reserves.

Of course, there is a benefit of this system: the stability of
the value of a currency will be maintained and inflation is
unlikely if the system is consistently applied. However, in
developing countries, this is no easy thing to do. The experience
in Argentina shows that CBS has not only collapsed but that this
system has failed to withstand a serious economic crisis.

In both developed and developing countries, there is enough
evidence to show that the independence of the central bank is
very helpful in the creation of economic stability, particularly
in monetary terms such as a low-inflation rate and a stable value
of the currency. That's why interest rates can be competitive.

BI alone has a good experience as an independent institution.
In 1999, following a deep economic crisis, BI played a major role
in lowering the inflation rate from around 70 percent to only 2
percent and, also, in strengthening the exchange value of the
rupiah from about Rp 15,000 per US$1 to around Rp 6,700 to the
dollar.

Unfortunately, very often BI has failed to work to the optimum
owing to frequent political intervention.

There is fear, though, that BI's independence will create a
state within a state. This fear is exaggerated. BI is independent
only in the implementation of monetary policies, particularly in
determining the amount of the money in circulation and
controlling the rate of inflation, as reflected in the interest
rate.

The independence of BI is also institutionally confined in the
sense that the central bank's board of directors cannot be
discharged from office unless they violate the prevailing laws.
This independent state of BI is open to accountability, which is
directly monitored by the House of People's Representatives, or
through the central bank's Supervisory Board proposed by the
House. These matters were discussed in debates on the amendment
to the law on the central bank.

Furthermore, the amendment of the Law is also focused on the
composition of the board of governors of BI and also on how they
are appointed. It seems that the House's working committee
assigned to amend the Law agreed that the names of the governor
and senior deputy to governors should be submitted by the
president with the approval of the House. The governor and
members of the senior deputy can come from political parties.
However, these people must fulfill the requirement that while in
office in BI, they must give up direct relationships with the
political parties concerned.

As for the number of deputies to the governor of the Bank of
Indonesia, it is still now a topic of discussion between the
government and the House with the Bank of Indonesia undertaking
separate monitoring. The present number of five deputies is
considered adequate. As stated in Law No. 23/1999, a deputy
governor of BI had better be proposed by the bank's governor,
coming from BI itself and getting the House's approval.

Given that it is likely that its governor and senior deputy
governor will come from outside - even politicians stand a good
chance now - it would be better if the deputies to the governor
come from within the bank itself.

In this way, the work of the board of governors will be
effective, particularly in organizing the bank's bureaucracy and
maintaining the continuity of monetary policies.

The establishment of the board of supervision, as proposed by
the House, can be accepted as an instrument which will assist the
House in exercising control over the bank's performance without
intervention in the stipulation of the policies of the central
bank.

Its main job will be to monitor the performance of the board
of governors, in particular, and its performance in general. It
is also part of its job to submit a report to the House and give
a recommendation on what steps the House should take either in
the context of promoting the bank's performance or in overcoming
the problems that arise, be they related to the scope of duty of
BI or to efforts to overcome economic problems in general. The
bank's board of supervision can reinforce the process of
accountability in the House.

As for the government's proposal that BI allows an interest on
the government's account in this bank, it seems that this will be
somewhat financially burdensome to the bank, especially in the
present transitional period.

Likewise, the desire to charge interest on the minimum
reserves requirement of banks will be very burdensome,
financially, to BI. These matters had better be excluded from the
law. If the economic condition improves, they may be discussed
again.