Camdessus' advice

Camdessus' advice

The two biggest challenges in the financial sector which IMF
Managing Director Michel Camdessus says are facing the ASEAN
countries in today's global economy are precisely the problems
Indonesia is coping with at present. The challenges, according to
the chief of the International Monetary Fund, who addressed a
conference on macroeconomic issues in the ASEAN countries in
Jakarta last week, are related to the sustainability of large
current account deficits and the soundness of domestic financial
systems.

Earlier, in his analysis, Camdessus reiterated the secrets of
the success of most ASEAN countries in achieving high,
sustainable rates of economic growth. Among the most important
factors are prudent fiscal policies, high domestic savings and an
attractive investment climate. Other important ingredients which
have made the high growth not only sustainable but also of a high
quality include an outward-oriented and market-friendly strategy,
strong emphasis on infrastructure investment and anti-poverty
programs.

The challenge related to the current account deficit was
caused by the globalization of the international financial
markets and by the very success of the ASEAN countries, including
Indonesia, in terms of attracting large sums of capital inflows.
The problem arises because quite a significant portion of the
inflows often consists of short-term capital, which can suddenly
fly out either because of wild rumors, contagion effects or
changing financial market conditions in other markets. The large
inflows tend to raise aggregate expenditures and increase
inflationary pressures, thereby widening the current account
deficits.

Many countries in this region obviously still remember the
burden they suffered from the impact of the financial crisis in
as far away as Mexico in early 1995. Indonesia itself was then
forced to draw down more than US$500 million from its foreign
reserves to defend the rupiah against currency speculators.
Smaller waves of currency speculations occurred over the past 18
months. The government has taken several measures to curb short-
term capital flows and to attract more foreign direct investment.
Direct investment is more stable because it is not influenced by
short-term outlook, but instead looks more at the fundamentals of
the economy.

The central bank's move last September to widen the exchange
rate band of the rupiah against the American dollar to 8 percent
was designed specifically to help curb currency speculation.

Bigger challenges, however, remain with regards to the
soundness of the domestic financial system, notably the banking
industry. The enforcement of the prudential banking rulings has
yet to be strengthened. Bank Indonesia's Governor, Soedradjad
Djiwandono, admitted that many banks still failed to conform with
the legal lending limits and the loan-to-deposit ratio.

Soedradjad has warned that the central bank would not
hesitate to take action against banks violating the prudential
regulations, but the warning apparently needs to be translated
into actual measures. Many analysts suspect that the central bank
is not as powerful as its counterparts in other countries in
dealing with politically well-connected banks. The matter is
often complicated by the special characteristics of banks, which
do not allow the central bank to publicly disclose what measures
it is taking against problem banks.

However, as Camdessus noted, problems in the financial sector
cannot be prevented by prudential regulations alone. Appropriate,
firm monetary and fiscal policy measures are required before a
problem bank deteriorates to the point that forces the central
bank to launch a bail-out in a bid to prevent the systemic risk
of a bank failure. Given the fiduciary responsibility of banks
and the multiplicity of transactions they are usually engaged in,
the failure of a bank usually hurts a large number of depositors
and could trigger a domino-like collapse of many other banks and
their corporate customers. But it is precisely because of the
systemic risks that the central bank should act firmly and
indiscriminately against problem banks.