Forex controls would create new problems

Forex controls would create new problems

Debate on the possible adoption of foreign exchange controls
to stabilize the rupiah's exchange rate is heating up after
Malaysia imposed such a system earlier this month. Economist Kwik
Kian Gie discusses the possible impacts of the proposed plan.

JAKARTA (JP): After economist Paul Krugman delivered a speech
and Malaysia decided to impose a controlled foreign exchange
regime, there was lively public discourse last week on the
possibility of Indonesia following in Malaysia's steps. But how
the regime would work, what impacts it might cause and what goal
might be achieved were not clearly discussed.

Such a regime offers several grades of rigidity. If Indonesia,
for example, adopts the most rigid system of capital control, no
citizens will be allowed to keep any foreign currency on them.
Anyone holding foreign currency would be required to sell it to
Bank Indonesia, the central bank, at a designated conversion
rate.

As a consequence, exporters will have to convert foreign
currency they have earned into rupiah at the central bank.
Violations of such a requirement would be regarded as a criminal
act subject to punishment.

What may happen then? The government would convert part of the
deposited foreign currency into rupiah. Indonesians depositing
their foreign currency at foreign banks will surely be reluctant
to convert their money into the domestic currency.

Considering that many Indonesians have deposited their foreign
currency at banks in other countries, particularly during the
last 14 months of economic crisis, hundreds of billions of
dollars -- far exceeding the level of the government's foreign
exchange reserves -- owned by Indonesian citizens will remain
beyond the control of the government.

Exporters will have to convert their foreign currency into
rupiah because they generally receive the prices of their goods
through letters of credits (L/Cs). But they will underprice their
goods in a bid to reduce the amount of money they will have to
convert into rupiah. They will save the difference in overseas
banks.

Importers, on the other hand, will overprice the goods they
import, so they can obtain larger allocations of dollars that
they will be allowed to buy from the central bank. They will then
deposit the dollar surplus in foreign banks.

Anticipating the possibility of such practices, the government
will introduce control prices on millions of export and import
commodities, so that the government can calculate the amount of
dollars it will receive from exporters and determine the amount
that it can sell to importers.

Such bureaucracy will retard the flow of goods and force the
government to expand its bureaucracy, which, in turn, will lead
to corrupt practices, such as the introduction of illegal levies
and the commercialization of power to control prices.

Because the proposed foreign exchange controls are aimed at
stabilizing the rupiah's conversion rate -- so that manufacturers
can afford to buy foreign currency at relatively low prices --
the government will also have to sell it at the designated
prices. But will the government have adequate amounts of foreign
currency to meet the demand, not only for imports but also for
overseas travel, health care, schooling etc?

Realizing that Indonesia's balance of payments has always been
well in the red in the past year, the government will have to
tightly select from the millions of applicants wanting to
purchase foreign currency every day. This, again, will be a
process vulnerable to corruption.

Because the government will strictly limit the official sales
of foreign currency for the purpose of benefiting the country,
affluent people who need foreign currency will buy at a higher
conversion rate than owners depositing their money in overseas
banks -- which will be beyond the government's control.

Such transactions will surely lead to an illegal or black
market -- as happened at Pasar Baru in Central Jakarta during the
Old Order government -- if the amount is small. If the amount is
large, the seller will issue a personal cheque for the buyer, who
will be able to cash it at the seller's bank in a foreign
country.

Thus, there will be two markets, an official one providing
foreign currency at low prices, and an illegal or black one
charging higher prices.

Imports of luxury goods will be paid with money from the black
market and brought into the country as personal effects. If
customs officers do not believe the owners' claim that the goods
are presents from friends overseas, the owners will offer them
bribes.

Then, what is the use of foreign exchange controls originally
aimed at protecting the government's foreign exchange reserves
and curbing inflation? Practically, as proven during the Old
Order era, prices of imported goods will remain high because they
will be set on the basis of foreign exchange values quoted on the
black market.

The underpricing of exports and the overpricing of imports
will distort statistics on international trade. Furthermore, the
selection of people eligible to buy foreign currency and the
introduction of control prices for exports and imports will
require bureaucratic expansion, which will undoubtedly lead to
further corruption.