Tracking capital flows

Tracking capital flows

Starting this month banks and their customers, including
foreigners holding stay permits and Indonesians residing
overseas, are required to prepare more detailed reports on all
foreign exchange (forex) transactions in excess of US$10,000.
They have to disclose the identities of the remitter and
recipient of these funds, the type and purpose of each
transaction, and the financial relationship of the transactors.

However annoyed bank customers might be with the additional
paperwork, they can rest assured that the new ruling has nothing
to do with any plan to impose forex control and that all reports
will be kept confidential.

Such documentation is necessary as banks are now required to
keep detailed accounts of all forex transactions they conclude
for themselves or on behalf of their customers and submit them in
monthly reports to Bank Indonesia (central bank) beginning April
1. A technical mechanism is still being prepared for compulsory
reporting by nonbanking financial institutions, which typically
accounts for only less than 20 percent of total forex
transactions.

The new procedure implements Law No. 24/1999 and is designed
to keep Bank Indonesia apprised of capital flows of foreign
exchange to and from the country and will enable it to adopt a
more effective monetary policy. The compulsory reporting on forex
deals was prompted by the financial crisis that hit the country
two years ago.

When a massive run hit the rupiah immediately after the
currency's free floating in mid-August 1997, Indonesia's central
bank was completely in the dark when it came to understanding
just how much the country's need of foreign exchange was. More
shockingly, it was unable to track foreign exchange flows in and
out of the country, nor was it able to calculate the extent of
private companies' foreign debts.

Only after speculative attacks on the rupiah escalated,
setting off a feverish stampede of hard currency out of the
country, did Bank Indonesia begin taking stock of just how much
the private sector really owed to foreign creditors. When the
final count was completed in mid-1998, the conclusion was a
shocking one: companies and banks owed a staggering total of more
than $75 billion, mostly in short-term debts.

The central bank was never able to estimate with any real
accuracy just how much capital flew out of Indonesia at the peak
of the currency crisis, this being in the first quarter of 1998
when the rupiah fell as low as Rp 17,000 to the dollar. Private
estimates put the capital flight at between $18 billion and $30
billion.

Commendably, the government, in spite of the devastating
impact of the rupiah's free fall, did not resort to clamping
down, as Malaysia did, by instituting forex control to cope with
the panic. By drawing an important lesson from the situation, the
government drafted a bill on reporting forex transactions which
was enacted by the House of Representatives last April.

Though the reporting system will impose additional work on
banks it will not, however, cause excessive mountains of
paperwork, for only transactions worth over $10,000 will have to
be accounted for in detail. Transactions valued up to $10,000 can
be reported in a lump sum.

Surely up-to-date reporting will provide the central bank with
accurate, comprehensive and timely data on forex deals, enabling
it to have a more comprehensive understanding of its external
balance and international investment, a prerequisite for devising
effective monetary policies.

The question now is what will make the new law more effective
than similar regulations in the past. Since the early 1980s,
private companies, including banks, have also been required to
report forex deals, notably foreign borrowings to Bank Indonesia;
but the end result, apparent to all in late 1997, was that the
central bank remained completely in the dark about capital flows
in and out of the country.

Surely the condition now is different under new regulatory
environment and exchange rate policy. The penalties stipulated in
the law -- which range from fines amounting to Rp 100 million
($13,300) for nonreporting and Rp 5 million a day for any delay
in reporting, to suspension of business licenses for six
consecutive months of nonreporting -- would go a long way in
forcing banks to make monthly reports. The free floating of the
rupiah makes the monitoring of forex flows an urgent necessity so
that the central bank can conduct effective management of funds.

Also most important is that different from the past when Bank
Indonesia was often made powerless in dealing with politically
well-connected banks and companies, it is now vested with strong
autonomy by virtue of the new Central Bank Act enacted last May
and is therefore more powerful to enforce laws on monetary
affairs.