Control of short-term capital flows 'necessary'

Control of short-term capital flows 'necessary'

JAKARTA (JP): Indian economist C. Rangarajan suggested on
Friday that countries in crisis, including Indonesia, control
short-term capital flows to prevent a recurrence of similar
financial crises.

Rangarajan, the governor of Andhra Pradesh state in India and
a former governor of the Reserve Bank of India, said short-term
flows should be controlled so they would not enter a country
excessively.

"The East Asian crisis emphasizes the need for a watch on
short-term, volatile capital flows, which have destabilizing
effects on the economy," he said at the India-ASEAN lecture
series here on Friday.

One way to control short-term flow would be to manage short-
term corporate debt as a proportion of total external debt,
within reasonable levels.

When the capital account is open, as in the case of Indonesia,
the exposure of the private sector needs to be monitored, he
said. And it also is important that the exposure of corporations
are properly hedged, he added.

Another way to control short-term flow would be by regulating
portfolio investment, Rangarajan said.

But there is no consensus yet whether portfolio investment
should be treated as a destabilizing flow and whether
restrictions should be imposed on them, he added.

Nevertheless, as long as the restrictions are pursued by using
market-based instruments, they will be accepted as necessary, he
said.

Another way to manage short-term flows would be through an
ideal exchange rate regime, Rangarajan said.

But there is no consensus regarding such a regime, he said,
adding that keeping the exchange rate within a band centered
around a real effective rate would be a good operational guide.

This is particularly true for countries where exports
constitute an important proportion of the gross domestic product,
Rangarajan said.

He said the real effective exchange rate provided a reasonable
indicator of the export competitiveness of a country.

Whatever the exchange rate regime adopted by a country --
pegged or managed floating or free floating -- it should not be
linked to a single currency. It must have relationship to the
group of countries with which the country trades, he said.

"However, credibility in a currency is a function of many
factors, including sound macroeconomic policy."

The loss of confidence in a currency could be triggered by
genuine fears, if the policies pursued are not considered to be
appropriate, he said.

"Even honest foreign investors, and not necessarily
speculators in the sense of predators, may begin to withdraw. A
sound economic policy with a well functioning and safe financial
system are equally necessary."

Therefore, Rangarajan said it was necessary for countries in
crisis to build a sound financial system to stem short-term
volatile capital flows.

"A strong financial sector is also critical to sustainable
growth."

For the financial sector to become sound, the most important
requirement is for a regulatory and supervisory framework which
enforces transparency, competition and accountability, he said.

Rangarajan also said information disclosure should conform to
international best practices and internationally accepted
accounting standards.

To maintain sound financial systems, Rangarajan said banks and
other financial institutions should refrain from pursuing
excessive credit expansion.

And those financial institutions should also refrain from
excessively financing non-tradable sectors, such as real estate,
he added.

Data indicates banks' real estate loans account for from
between 25 percent and 40 percent of their total assets in
Indonesia, Malaysia and Thailand, and 15 percent and 25 percent
in South Korea and the Philippines. (rid)