Capital control revisited

To many, the wooden communiques issued after the huffing and puffing at the series of meetings held by the world's financial leaders in Washington in light of the annual meetings of the IMF and World Bank over the past six days had a familiar ring.

The focus remained on unfettered markets and on the need to strengthen the international financial system through greater transparency in both the public and private sectors. The bedrock of sound financial markets was reiterated: sound capital flows, internationally-accepted accounting and auditing standards, fuller financial disclosure and the timely dissemination of economic data by central banks to market operators.

There is nothing wrong with reiterating these basic tenets. They are required to remind all countries currently embroiled in financial crises that there is no quick fix to regaining market confidence. Transparency is the fundamental rule in the market game because the financial industry is extremely sensitive to any information, good or bad.

However, beneath the shouting in support of free movement of capital, a quieter but increasingly persuasive case was being made in favor of capital controls such as those imposed by India, China and Chile almost a decade ago and by Malaysia early last month.

Even IMF and World Bank economists are now prepared to acknowledge that controls on capital movement, while never an effective long-term measure, can be appropriate under certain circumstances. The IMF Executive Board has been assigned to review experience with the use of capital controls and the circumstances under which such measures may be appropriate.

Indonesia, apparently frustrated by slow progress made in its painful struggle to strengthen the battered rupiah, has been tempted into flirting with some forms of capital control. But extra caution is warranted. Indonesian circumstances are very different from other nations which had capital controls that buffered them from the very worst effects of the financial crisis.

Bureaucratic incompetence and government credibility pose the biggest hurdles to any form of capital controls in Indonesia. It is doubtful if the government would be able to administer any such measures effectively. The biggest inherent risk in capital controls is their enormous susceptibility to corruption. Given this, the nation's huge foreign debts and the country's geography -- it is the world's largest archipelagic state -- outright capital controls such as those adopted by Malaysia are out of question.

Compulsory surrender of exporters' dollar earnings to the central bank, one of the options cited by Coordinating Minister for Economy, Finance and Industry Ginandjar Kartasasmita in Manila on Wednesday, would be equally counterproductive. Any such requirement, besides being too complex to administer and supervise, would immediately kill what little is left of domestic investor confidence. Our economic condition now is such that only domestic investor confidence is capable of reigniting foreign investor interests in the country.

The most viable option and the one most likely to get IMF approval is not outright capital control but rather a regulatory regime to improve the monitoring of external liabilities and curb foreign borrowing. Along this line, the system used by Chile would be the one most suitable to Indonesia's circumstances. Chile has since the early 1990s taxed short-term capital flows, which in most countries are the main source of market volatility. Discouraging the inflow of speculative capital also seems more sensible to foreign investors. It prevents investors feeling like they have been trapped after entering a market, which is the most likely impact of tighter controls on capital leaving the country.

Whatever decision is eventually taken, one thing is for certain. The government should not leave the market hanging in uncertainty. Since it has now been confirmed that some form of capital control is under consideration, the final decision must be taken soon.

The situation is desperate. Massive bank restructuring, a prerequisite to economic stability and recovery, will be ineffective if not accompanied by a cut in interest rates. Even the few good, strong banks and sound companies remaining in the country could collapse within the next few months if the central bank's benchmark interest rates remain above 50 percent. The health of the banking industry is highly dependent upon a strong and stable economic environment with a vibrant and viable corporate sector.

In the final analysis, whatever additional measures are eventually taken to manage external assets and liabilities, they should be an integral part of the many other dimensions of economic policy and good corporate governance. Most importantly, the measures should by no means kill the fundamental principle of open-capital accounts that allow capital to move freely to find the most profitable and productive investment, no matter what country that happens to be in.