Our forex management

Bank Indonesia's recent decision to widen the buying-and- selling spread (exchange rate band) of the rupiah against the American dollar should be welcomed as effectively discouraging foreign exchange speculation for at least three main reasons.

Firstly, the exchange rate band was widened from Rp 30 to Rp 44 late last month when the international foreign exchange market, which was highly volatile in March and April, was relatively calm. Had the measure been taken amid a wildly fluctuating market, it could have caused jitters and even triggered a rush on the dollar.

Secondly, though most analysts considered the exchange rate band still too narrow to significantly deter short-term speculation, the gradual widening prevents unnecessary concerns.

Now that the exchange rate band ranges from Rp 2,224 to Rp 2,268 per U.S. dollar, Bank Indonesia has more leeway in its monetary policy. It is also better able to adjust prices on the foreign exchange market in order to absorb short-term capital flows which tend to be highly volatile, as the waves of capital flight in early 1994 and 1995 proved.

More important, as Bank Indonesia's Governor Sudradjad Djiwandono explained, the move was designed to enhance inter-bank foreign exchange transactions. Since the private market makers are now allowed more room for price adjustments, the brunt of foreign exchange rate risks is now placed on currency speculators.

The measure is not likely to cause many problems for banks because of Bank Indonesia's decision last September to ease the limit on net open external positions of financial institutions (the total amount of on and off-balance sheet assets and liabilities in foreign currencies) from 20 percent to 25 percent of paid-up capital. That means the net of assets and liabilities in foreign currencies can now reach 25 percent of their paid-up capital. Further down the road, the measure will allow banks to borrow more from the offshore markets.

Finally, the wider exchange rate band is even more essential after the U.S. Fed's move last week to lower its short-term interest rate by 25 basis points to 5.75 percent.

Since Indonesian banks will not likely follow suit, given the persistently strong inflationary pressures and tight monetary conditions, the differences between Indonesian and American interest rates will widen and make the country more attractive to short-term capital. But the wider exchange rate band will at least slow down the pace of short-term capital inflows.

It should be noted, though, that the measure is and should only be part of a sound macro-economic management plan. The best protection against turbulence on the international financial market remains consistently prudent macro-economic policies that further strengthen economic fundamentals.