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.