Independent BI

The draft law on the central bank (Bank Indonesia), proposed to the House of Representatives on Wednesday, is part of the overall restructuring of the banking industry. The legislation, designed to shield the monetary authorities from the myopic interests of politicians, will address one of the main obstacles to the development of a sound banking system: political interference, which, aside from the lack of technical competence, has often been cited as one of the causes, if not the main reason, behind the banking crisis now engulfing the nation.

The fact that most problem banks have committed egregious violations of legal lending limits testifies to the central bank's impotency in enforcing its prudential rulings on banks with strong political connections. The huge sum of bad credits suffered by state banks and the profile of their main borrowers show how dominant political influence has been in the lending decisions made by directors of public banks.

The long-awaited legislation will provide a legal basis for the central bank's authority in maintaining monetary stability, safeguarding the rupiah and setting aggregate monetary targets.

Though the central bank's governor will still be appointed by the President, his deputies, called managing directors, are nominated by the governor and all are secured with a five-year tenure. They cannot be fired by the President. They can resign in special circumstances and can be sacked only if they are convicted of criminal acts.

However, independence or autonomy alone is not effective enough to enable the central bank to perform its task properly. Past experiences have shown that Bank Indonesia, as a result of the 1968 Central Bank Act, has been tasked with so many missions that often the bank's duties have conflicting objectives.

The new law therefore seeks to eliminate the central bank's role as supervisor of the banking sector by mid-2000. An independent body is to carry out this function, and the central bank will resume its role as a lender of last resort in the real sense. This means that the central bank will provide emergency funds only to temporarily illiquid banks, and not to insolvent banks, as it has done until now. Bank Indonesia will also be freed from the task of providing subsidized credit to farmers and small businesses and other government-sponsored development programs.

Its autonomous status will not, however, mean that the central bank's policy-making process will be detached from the complex process of macro-economic management. The draft law specifically stipulates that the central bank's governor, though not a member of the ministerial cabinet, attends cabinet meetings and that the economics minister is present at the central bank's monthly meeting.

But granting statutory independence to the central bank to protect it from the hurly-burly of politics is not in itself a guarantee for excellent performance. After all, the central bank does not operate in a vacuum. Hence, it also needs a constructive policy environment, meaning a government which looks beyond the short-term political costs of its actions and focuses on the long-term good of the economy.

Having the right people in the central bank is another prerequisite. The central bank's governor, managing directors and other key personnel must show not only excellent professional qualifications but also a convincingly high degree of personal independence and integrity.

Autonomy could lead to arbitrary decisions if the central bank's independence is not underpinned by openness, transparency and accountability. It is most important therefore that the central bank announces to the public its annual financial targets as a guidepost to its monetary policy stance in the year ahead. The declaration of quantitative targets demonstrates the projected path of monetary policy for everyone to follow and to consider when making financial decisions. As, in the final analysis, public support is pivotal to the effectiveness of the central bank's monetary policies.