Indonesia rules out foreign exchange control option

JAKARTA (JP): Coordinating Minister for Economy, Finance and Industry Ginandjar Kartasasmita dismissed rumors on Wednesday that Indonesia would follow Malaysia and impose foreign exchange controls.

"We will stick to the free foreign exchange system for the time being, but we will continue to study new developments," he told reporters after a cabinet meeting.

Rumors have been circulating in Jakarta's financial community that Germany's Deutschebank is studying various models of capital controls which may be suitable to stabilize the rupiah.

The German central bank is giving technical assistance to the government to solve various financial problems, including restructuring the banking sector.

The speculation has it that the exchange rate will be fixed in a certain band once the rupiah hits Rp 10,000 to the U.S. dollar.

The currency strengthened to Rp 10,800 Wednesday from more than Rp 11,000 the previous day.

Bank Indonesia director Miranda Gultom said last month that returning to a managed exchange rate system was an option, but said later that the central bank would not take steps that would only provide short term fixes at the expense of long-term stability.

"We have no plans to impose capital controls at the moment," BI director Achjar Iljas told The Jakarta Post.

Malaysia surprised financial markets Tuesday when it imposed capital controls to stabilize the ringgit by effectively pulling the currency out of international circulation and fixing the exchange rate at 3.80 to the U.S. dollar.

Economists have warned the Indonesian government not to copy Malaysia's move as it would only further damage investor confidence in the crisis-hit economy.

Pande Raja Silalahi, an economist at the Centre for Strategic and International Studies, said on Wednesday that copying Malaysia's move may cost Indonesia dear as it would scare away foreign investment, which is badly needed to kick-start the recovery.

"Such a move would only send a wrong signal to the market because confidence is very low at the moment," he told reporters following a seminar.

He added that the current government had neither the capability nor enough support to prevent the capital control system from being abused.

"Even the Governor of Bank Indonesia is not sure of how long he can stay in office," he said.

Pande also said that imposing capital controls would put Indonesia in a confrontation with the IMF, which has a commitment to provide a multi-billion dollar bailout funding for the country.

The Fund is acknowledged to be strongly against any restriction on capital flows.

"The evidence on the effectiveness of capital controls is weak," said Ali Wardhana, a prominent economist and long-time adviser of the Soeharto administration.

He explained that measures such as those employed by Chile, the most famous example of supposedly successful controls, could work to reduce the proportion of short-term and portfolio capital relative to long-term equity investment.

"But a careful reading of Chile's experience suggests that such controls work only in the short-run, if they work at all," he said in a recent seminar.

"Over the longer term, capital controls have been shown time and time again to reduce the level of capital inflow, thus reducing investment growth. They appear to have little effect on the real exchange rate or on the current account," Wardhana said.

The country's economic crisis with the rupiah already losing some 80 percent of its value since July last year, has prompted some experts to propose various forms of capital controls.

The Indonesian Institute of Sciences has proposed a two-tier forex system, under which the government would provide a lower- than-market-exchange rate for exporters to import raw materials, but exporters are required to surrender their forex revenue. (rei)