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.