Indonesian Banks Facing Stricter Forex Rules to Tame ‘Hot Money’

Jakarta Globe, Francezka Nangoy & Faisal Maliki Baskoro | December 29, 2010

The central bank plans to compel domestic lenders to increase their foreign exchange reserves deposited at Bank Indonesia starting in March to rein in hot money that could threaten the country’s economic stability.

Rather than imposing capital controls, Bank Indonesia is seeking
to calm high levels of foreign direct investment by raising domestic
bank reserve rates and encouraging moderate loan-to-deposit
ratios.(JG Photo/Safir Makki)

“The reserve requirement will be increased in two stages: to 5 percent on March 1, and then raised to 8 percent on June 1,” said Darmin Nasution, governor of Bank Indonesia. Currently, banks are required to set aside 1 percent of their foreign exchange deposits as reserves.

Analyst estimate that the move by the central bank could soak up as much as $2.5 billion in liquidity from the market.

BI has been wrestling with the surge in foreign capital in the past year as near-zero interest rates in the West and Japan have prompted investors to seek higher yields in emerging economies such as Indonesia. Although foreign funds support growth, they drive up prices and have the potential to create asset bubbles, which could create havok when they burst.

The central bank has refrained from raising its benchmark interest rate, instead opting to increase bank reserve requirements and introducing measures to require investors to keep their money in the country for longer periods of time.

“The policy will be implemented in stages to allow banks more time. The policy will be evaluated from time to time to reflect the real economic condition,’’ Darmin said on Wednesday.

Starting on Nov. 1, BI required lenders to set aside 8 percent of their rupiah deposits as reserves, up from 5 percent. The central bank also said it would introduce an additional reserve requirement in March that would penalize banks with loan-to-deposit ratios below 78 percent or above 100 percent.

Darmin said the country saw an influx of $16.2 billion worth of portfolio investment flow into the economy in 2010, while foreign direct investment rose to $12.2 billion in 2010 from $5 billion just a year earlier.

Another policy that will be implemented to minimize the risk of sudden capital flight next year limits the amount of size of short-term loans foreign entities take from a domestic bank to not more than 30 percent of the lender’s total capital. BI hopes the move will lead to more prudent management of the loans as well as longer credit terms. This policy is to take effect by the end of January.

Darmin added that with these measures there was no need for capital controls to cool inflows.

“What we need now is to manage the capital inflow by setting the reserve requirement, deepening the capital market and always being aware of global financial volatility,’’ he said.

Economist have hailed the move. “It is a positive step as it could reduce the cost of monetary operation,’’ said Destry Damayanti, an economists at Mandiri Sekuritas in Jakarta.

“This policy is needed to absorb excess liquidity in the market. This policy is a better alternative in stabilizing the economy compared to increasing the BI rate,’’ Destry said. She added that raising the reserve requirement to 8 percent might make it difficult for banks to channel foreign-exchange credit.

BI has kept its key rate at a record low 6.5 percent since August 2009, which while historically low for the country is among the highest in the region.

Related Article:

Indonesia Tightens Rules on Foreign Exchange Holdings, Overseas Borrowing