Capital controls can have negative impact

JAKARTA (JP): Imposing capital controls as a way of preventing the financial turmoil in Indonesia from worsening would negatively impact the economy, a veteran economist says.

Former minister of finance Ali Wardhana said yesterday that strict exchange controls and a closed financial market would be ineffective in curbing the contagion of the currency crisis in the region from spreading.

"Flat out capital controls are an invitation to corruption and inefficiency," Ali, now an economic advisor to the government, said when he opened a two-day conference on "Sustaining economic growth in Indonesia: A framework for the 21st century".

Less extreme remedies such as a global transaction tax "would serve to throw sand in the wheels of superefficient financial vehicles", he said.

"All of the proposed remedies are second-best solutions... (which) make sense only if the policy choice is so constrained that only the use of nonoptimal measures can increase welfare," he said.

Ali argued that if the constraints in the policy choice were real and binding, a tax on capital inflows would reduce welfare as well as fail to ensure that rapid capital inflows were invested properly.

He said there should be considerations whether the proposed measure to control capital flows could restrain domestic speculators, many of whom were also involved in currency dealings.

The restraints should also include costs and benefits in a broader calculation, he added.

Ali stressed the need for better reporting on private capital inflows to prevent an excessive flow of funds from being invested poorly.

"One would hope for data that would flag any dramatic decline in the risk-adjusted spread between yields in emerging market securities and the yield on some international benchmark securities," he said.

Such a measure would allow the government to take steps to ensure that there was neither an unjustified level of capital inflows nor rapid outflows, he said.

Policy makers could then judge whether such a decline was justified by underlying economic conditions or reflected unwarranted euphoria, he said.

The conference was organized by the United States Agency for International Development jointly with the University of Indonesia's School of Economics and the American Committee on Asian Economic Studies.

The first-day session yesterday presented government and private sector economists who covered macroeconomic and microeconomic issues.

Most severe

State Minister of National Development Planning Ginandjar Kartasasmita, who addressed the luncheon session, considered the economic crisis not only the most severe but also the first of its kind in the country in the past 30 years.

Shocks in the past were more or less a problem of government adjustment... but the more serious problem now lies in corporate finance, Ginandjar noted.

He said the nation was not only in a monetary crisis, but also the effects of the El Nio weather phenomenon had made agricultural growth almost stagnant.

"Thus, just when we need it, a strong agricultural sector cannot provide the stimulus to the overall economic growth we need," he said.

Ginandjar foresaw real difficulties over the next year or two as confidence had been lost and the shock to the economy was very great.

"The key to a successful recovery is staying the course of reforms already in place and continuing with further reform measures. But if people do not perceive that the burden is being shared broadly, they will look for the easy solution," Ginandjar warned.

He suggested two ways of ensuring that the burden of adjustment was being shared equitably.

"First, we must press ahead with policy reforms that level the playing field, are transparent and are applied fairly and justly.

"Second, we have to make sure that we put in place safety net policies designed to reduce the burden on those most in need during the crisis."

Ginandjar assured the business community that in spite of the current difficulties, the Indonesian economy would continue the trend toward a more outward global orientation and the role of foreign investment would continue to grow.

He saw a continued pursuit of the domestic reform agenda as the most critical element for development in the long run.

"At the heart of our predicament lies serious institutional problems. Lack of transparency, not only in public policy but also in the private sector, had muddied important signals and led to complacency and finally more serious problems," he pointed out.

Another panelist at the meeting, economist Arnold Harberger from the University of California in Los Angeles, U.S., observed that the present turmoil would lower the level of capital inflows to Indonesia from previous years.

"With all the recent turmoils, the old level of inflows will unlikely be restored in one or two years," Harberger said.

Indonesia would be lucky to have the level of inflows restored in three to four years, he added.

However, the magnitude of the crisis in the Indonesian economy would unlikely be as big as that which had occurred in Latin American countries, he said.

Indonesian exports would benefit from the currency depreciations, he said.

He said he was confident that a real exchange rate would apply in the economy within the next six to 18 months after economic reforms took place.

This would require prudent governmental policies and the authority's awareness in keeping touch with economic reality in the country, he said.

"The authority must keep the money supply in tune with economic reality," he said.

Some of the conditions following this would be a squeeze to credit for the private sector, he said.

The government must continue to eliminate economic distortions, including high tariffs and artificial monopolies, he said.

Transparency was also a critical part of economic reforms, he said.

If information was accurate and available, many boggles caused by rumors would be eliminated, he said.

Harberger said he was optimistic that Indonesia would emerge from the turmoil stronger than before.

"This is not a happy period for an economy to go through, but it is an event that is not cataclysmic, not catastrophic, it is not something without precedent," he said. (das/vin)

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