Curbing rupiah speculation

Frustrated with the decline in the rupiah's exchange rate to a level considered way below the economic fundamentals, Bank Indonesia moved on Monday to cut sharply the supply of the local unit which could be used for speculative purposes.

However, the market seemed to accept the measures quite well as the central bank stopped short of taking any form of foreign exchange control which, since last year, it had been rumored to flirt with. Any tinkering with the open capital account policy is considered virtual suicide now, given the country's heavy reliance on foreign aid and trade, and any drastic move is also considered unfeasible for the government's administrative infrastructure. Moreover, any form of foreign exchange control will not be acceptable to the International Monetary Fund which is leading a multi-billion dollar bailout for Indonesia.

The main essence of the latest policy measures is to slash the supply of rupiah that could be used for speculative purposes by banning domestic banks from lending rupiah or foreign currencies to non-resident borrowers, including foreign citizens and foreign legal entities, as well as Indonesians with permanent residence status abroad and overseas offices of Indonesian legal entities. This ban is in fact the reinforcement of an old rule which seemed to have been ignored.

The other measure involves the cutting down to US$3 million from $5 million the maximum amount that domestic banks can make in forwarding currency deals offshore. But this restriction will not adversely affect foreign trade and investment because it does not apply to hedging deals by foreign investors and creditors and derivative transactions which have underlying deals in Indonesia.

The central bank apparently is fully aware that any major outright limitations to the movement of currency would only create policy uncertainty and threaten capital inflow. Moreover, corruption and inefficiency within the government bureaucracy would make such a measure counter-productive.

This reason, we think, is also the major factor that has prompted the central bank from not making it compulsory for Indonesian exporters to expatriate their overseas earnings, an option that had earlier been suggested by several economic ministers, analysts and businesspeople.

Monday's measures are only the latest in a series of moves launched by the central bank to help control wide volatility in the rupiah rate. Last October, the central bank tightened its on- site supervisory presence at banks which were quite active in foreign exchange trading in order to better monitor the demand for foreign exchange.

Earlier last February, Bank Indonesia required banks to file monthly reports to the central bank on their foreign exchange transactions. Reports on individual foreign exchange deals amounting to figures in excess of $10,000 must contain more specific details such as the type and purpose of the transaction and the relations between the counter parties. This reporting requirement is designed mainly to keep the central bank apprised of foreign exchange flows in order to enable it to conduct and improve its monetary management.

But the monetary authority is also sensible in realizing that all these measures would not stop rupiah speculation outright but would at least help reduce the volatility of the rupiah rate.

The central bank fully realizes that speculation on the rupiah will remain highly active, and even Indonesian citizens will regularly shift from rupiah to a foreign currency position as long as the sovereign risks remain high due to political uncertainty.

But the latest moves are expected to reduce the supply of rupiah overseas that could be used for speculative purposes, especially now that many domestic banks are awash with liquidity but are still hesitant on resuming significant corporate lending due to the current major political and economic woes.