Capital controls can have negative impact

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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