Foreign funds will not create bubble: WB

The Jakarta Post, Jakarta | Wed, 10/20/2010 9:52 AM

Indonesia remains safe from the dangers of an economic bubble despite growing concerns that the currently large inflow of foreign funds into the country could push up asset prices to an unrealistic level, a World Bank economist says.

World Bank (WB) senior economist in Jakarta Enrique Blanco Armas said Tuesday that the large amount of foreign capital inflow into Indonesia’s debt and equity market had not yet posed a threat to the country’s economy.

“Whether [the capital inflow] will make a bubble in the Indonesian economy, it will be very little,” he told journalists after the launching of the WB’s latest East Asia and Pacific economic update titled “Robust Recovery, Rising Risks”.

However, he said, the central bank should avoid using an interest rate instrument to curb the inflation resulting from the increase in the liquidity as the consequence of the foreign capital influx. “An increase of the interest rate would attract more capital inflow,” he said. 

The central bank’s recent move to raise the reserve requirement in order to ease the liquidity was the right decision, he said. “It’s a correct one,” he stressed.

Driven by massive global liquidity resulting from a recovered global economy, capital inflows to developing countries have risen sharply this year. 

In Indonesia alone, foreign holdings of government bonds climbed by Rp 78.8 trillion (US$8.8 billion) this year to Rp 186.8 trillion as of Oct. 5. In addition, the foreign funds have pumped a net $2.4 billion into Indonesian shares so far in 2010.

“We have to keep a careful eye, because the volatility of capital flows may bring risks to the sustainability of the country’s economy,” Vikram Nehru, WB chief economist for the East Asia and Pacific Region, said in a teleconference from Tokyo.

A large amount of capital from developed countries had flowed to the East Asian countries to seek higher returns, he said.

“It’s complicating the policy makers. They have to manage the capital inflows to maintain the economic stability while, at the same time, they have to make sure that the economic growth is maintained,” he said.

To cope with the massive capital inflows, he said, the East Asian authorities would bear tough challenges in balancing the inflows by, among others, ensuring competitiveness, financial sector stability and low inflation.

He said East Asian growth was not only robust but also pretty wide spread because five countries in the region had their growth rates at about 7 percent. The growth was no longer driven by fiscal stimulus packages, since it was now driven by the private sector.

“Private investment is coming back, as well as consumption. So [the economic growth] will be more sustainable,” he said. (ebf)