Regulating Capital Outflows

Indonesia

Economic News

22 Jul 2010
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Following rapid currency depreciation and threat of large capital outflows, the government of Indonesia has taken measures to restrict foreign currency transactions and increase overall currency security.



Over the course of the last month, the Indonesian rupiah has fallen by 22% to a record 13,150 against the dollar - a drop not seen since the 1998 financial crisis. The currency's volatility and decline has created concern among large depositors, resulting in significant capital outflows to neighbouring markets.



This has prompted the central bank to implement a new regulation, effective December 1, which will restrict foreign exchange transactions. It requires Indonesian entities to provide tax identification and sufficient explanation for the purchase of foreign currency over $100,000, in an effort to minimise capital outflows to foreign markets and prevent further damage to the already sliding rupiah. The regulations are not unlike those currently in place in neighbouring countries such as Malaysia, which already requires justification for large foreign currency transactions.



Notably, the new legislation will only apply to Indonesian citizens and firms, as foreign investors will be able to bypass the regulation by purchasing foreign currency on the spot market. Foreign investors have proved vital to the recent economic success of the country through their significant investments in natural resources, and the government believes that maintaining their confidence and financial backing is of great importance to the country's long-term economic growth.



There has also been recent discourse regarding a proposed regulation, potentially effective within one month, which would require all oil and gas operators within Indonesia to exclusively use Indonesian banks to finance their large-scale operations. While this would be a tremendous boost to liquidity in the Indonesian banking sector, a selection of multinationals operating in the country have already expressed their concern.



Finally, a federal guarantee on bank deposits is an additional measure under consideration as a way to maintain capital control over financial markets. Many in the business community are calling for a full blanket guarantee, which they say would give depositors a much-needed sense of security. M.S. Hidayat, chairman of the Indonesia Chamber of Commerce (Kadin), recently issued a statement saying this kind if insurance was necessary in order to prevent further capital outflows to nearby markets such as Singapore or Malaysia, where deposits are already fully covered.



In a move to shore up depositors' financial security concerns, on October 13 the Indonesia Deposit Insurance Corporation's (IDIC) did increase the ceiling deposit guarantee from Rp100m ($9,050) to Rp2bn ($166,000). Under the new ceiling, 99.7% of all depositors are covered. While this is an increase of 1900% over mid-October levels, the small percentage of remaining uninsured depositors nevertheless account for 40% of the country's total deposits, according to the IDIC.



It is this income disparity that the government is using to argue against the implementation of a full blanket guarantee, saying 100% coverage would require the state to pay huge sums of money to the already rich, rather than focus on supporting the most vulnerable.



Vice-President Jusuf Kalla recently told the local press that a full blanket guarantee "was not immediately urgent...and would only create moral hazard among bankers...while potentially proving quite costly to the government".



But supporters of a blanket guarantee say it is necessary not to protect the rich, but to protect the rupiah.



Given the circumstances of tight liquidity, a weakened currency and high interest rates, how the Indonesian government reacts will be vitally important in minimising the long-term effects on the economy. Indeed, the present situation is reminiscent of the financial crisis of the late 1990's, when the rupiah dropped in value from pre-crisis levels of 2000 to the US dollar to over 18,000 at some points.



At that time, large capital outflows caused immense damage, and most experts argue that the government was late in implementing a blanket guarantee. This fact is still fresh in the minds of the business community, who are insisting on the urgency of the matter, in the process garnering the support of both the Bank of Indonesia and the Ministry of Finance. The fact that several markets in the region do offer a full blanket guarantee poses a serious threat to the financial stability of the market in Indonesia.



Rizal B. Prasetijo, managing director of J.P. Morgan Indonesia, told OBG, "The urgency for implementing a full blanket guarantee stems solely from the fact that other markets in neighbouring countries, such as Singapore, already provide a 100% deposit guarantee. If this were not true there would be no need for such legislation. Fortunately, the government we have right now is very proactive in communicating and listening to the needs of the business community, which has not always been true in the past".

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