The central bank was right to be concerned that another hike in its policy rate, which has been maintained at 6.5 percent since August 2009, could further increase interest rate differentials and attract more short-term (“hot money”) capital inflows.

The recent increase in inflation was caused mainly by food price volatility resulting from weather anomalies and associated supply disruptions. Hence, this time a tighter money policy would not have been the right cure.

It is not surprising, therefore, that the 23 monetary policy measures Bank Indonesia announced last week included instruments to drain liquidity by requiring commercial banks to keep larger sums in reserve at the central bank against their foreign currency deposits. These measures are short of direct foreign exchange control, which could have hurt Indonesia’s chances of making it to investment grade some time this year.

Starting in March, banks will have to hold 5 percent of their total third-party foreign currency deposits in reserve with the central bank, up from the 1 percent at present. This proportion will be further increased to 8 percent in June. According to a preliminary estimate released by the central bank, the move will absorb around US$3 billion in liquidity.

Then, as of early next month, Bank Indonesia will reinstate a rule limiting what are known as vostro accounts — short-term foreign borrowings in foreigners’ current accounts — to 30 percent of their capital.

The regulations are clearly among efforts to mitigate potential impacts of a sudden reversal in capital inflows.

Foreign ownership in government rupiah bonds amounted to Rp 196.83 trillion (US$21 billion) as of late 2010, or 30 percent of the total amount issued, one of highest proportions in the region.

The massive surge in foreign capital has also been accredited to the 46 percent increase in the benchmark Jakarta Composite Index to 3,703.51 points at the close of 2010.

On top of these precautionary measures, the ministries of finance and state enterprises last week signed an MoU on a scheme to require state-run companies to buy state bonds in the event of sudden outflows of capital.

The government is preparing a bond-stabilization fund to help protect the economy if a sudden capital reversal occurs. The idea is that state companies and financial institutions under the Finance Ministry’s jurisdiction would voluntarily allocate funds to buy bonds through a corporate mechanism should a reversal take place and foreign portfolio investors dump bonds on the market.

The rationale of all these rules and measures is that Indonesia needs foreign capital inflows to generate economic growth of 6.5 percent this year, but the torrent of short-term capital entering the economy needs to be managed to prevent a disorderly capital flight in the event of a panic on the domestic or international markets.

Popular

Hundreds of kitchens halt services due to 'pause' in free meals funds

Number of forcibly displaced people dips to 118 million: UN

Failed system, fake research