Sat, 26 Feb 2000

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)