Forex control, who needs it?

Forex control, who needs it?

The administration of President Abdurrahman Wahid seems to
have mastered the art of blaming everything that goes wrong in
this country on anything but itself. The weakening of the rupiah
these past two months is the latest example of that nagging
habit.

The currency has lost 14 percent in value in the last six
weeks, severely undermining the government's economic programs.
The fall, to a level of around Rp 8,400-8,500 last week, has
completely undermined the government's budget calculations which
are based on a rupiah value of Rp 7,000.

The government has laid the blame on the business community,
currency traders and speculators. With that in mind, the Cabinet
has been toying with the idea of imposing some form of foreign
exchange controls, or capital controls. But by deceiving itself
on the real cause of the weakening currency, the government has
focussed on treating the symptoms, not the illness.

Several Cabinet ministers have come out in favor of capital
controls, mooting the idea to generate public support. The plan
has apparently been discussed at Cabinet meetings, indicating
that the government was seriously considering it.

Typically, and not unexpectedly, the idea was quashed the
moment the International Monetary Fund (IMF) managing director
Horst Koehler arrived in Jakarta this week, providing more fuel
for future anti-IMF sentiments should the economy fail to pick
up. We will probably never know Koehler's precise words when he
met the President on Monday. But after the meeting, the President
completely ruled out the idea, something which he could have done
days ago and spared the nation from engaging in wasteful debate.

While the matter of capital control has been put to rest, at
least for now, for what it is worth, the controversy has provided
the nation with a valuable academic exercise. Hopefully, it has
given some insight to the government as to what course of action
it should take to restore the rupiah's value.

More than any other force, the rupiah's fall in recent weeks
must be attributed to a general decline in confidence in the
economy. This lack of confidence is also shown towards the
government.

The continuing violence in many parts of Indonesia, old and
new scandals in the government, uncertainties about the future of
the Abdurrahman's administration in the run up to August's
meeting of the People's Consultative Assembly, and many other
concerns have contributed to this political instability.

The fact that the monthly inflow of foreign currencies has
been below the export figures means that most export revenues
have been stashed in offshore banks. Wary of the political
situation in Indonesia, many exporters are playing it safe by
keeping their money abroad.

It is likely that no amount of foreign exchange or capital
control would prevent the rupiah from sliding given the current
situation. Nor would it be able to shore up the rupiah on a
sustainable basis. The strengthening of the rupiah towards the
end of last week was spurious, fanned by rumors of impending
capital control. It may have momentarily increased the rupiah's
value, but in the medium and long run, the rupiah will adjust
more to the country's political outlook and economic fundamentals
than to daily market rumors.

Foreign exchange controls, or capital controls, have merits in
certain cases, and they have been applied successfully in other
countries. Malaysia is a case in point, and because of its
proximity, many officials and analysts feel that the policy could
be adopted in Indonesia with equal chances for success.

The chief objection to foreign exchange or capital control is
that it distorts the market, that it will likely keep the
currency overvalued, exposing it to even more speculative
attacks. Such controls are only effective as temporary measures,
as in Malaysia.

A free foreign exchange regime remains a major incentive for
foreign investment. Reversing the policy will only undermine the
government's own drive to bring investors back to Indonesia.

The biggest concern about imposition of foreign exchange
controls in Indonesia is the fear of handing over more controls
than necessary to our inept and corrupt bureaucracy. For all the
talk about establishing a clean government, this administration
is far from ready to assume more power than it has today.

Any talk of establishing currency or capital controls, if they
are indeed desirous for Indonesia, clearly must wait for the
arrival of a cleaner and more professional bureaucracy. This then
becomes a moot point. For, with a clean and competent government,
we would probably never be in this mess in the first place.