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Indonesia’s new central bank law risks going back to the bad old days

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BANGKOK – While a so-called omnibus law has sparked ongoing protests in Indonesia, another measure shows that President Joko Widodo’s government and lawmaker are trying to bring time back to an earlier, less democratic era.

In early September, parliament suddenly announced the start of deliberations on changes to the 1999 Central Bank Act.

The proposal has three key points. The first is to remove the language on political independence from the Bank of Indonesia. The second calls for the transfer of monetary policy decisions from the central bank to a council chaired by the Minister of Finance. The third point is to extend the central bank’s mandate from price stability and exchange rates to economic growth and employment.

In short, the proposal would let the government control the central bank at will.

Responding to the concerns of market players, Finance Minister Sri Mulyani Indrawati pledged to respect the independence of the Bank of Indonesia. But she did not deny the need to change the law on the central bank. The bill is expected to pass through parliament, with the ruling coalition holding 70% of the seats in the lower house.

“Now the house, apparently with government backing, intends to reduce the independence of the central bank by demanding that it be more growth-friendly in its monetary policy,” Professor Haryo Kuncoro wrote, from Jakarta State University, in a local newspaper.

Electionist governments and legislatures, if left unchecked, tend to resort to expansionary fiscal policy and will go further by calling for easy financial measures to stimulate economic activity. This happens not only in authoritarian countries with insufficient checks and balances, but also in democracies.

The job of monetary policy is to maintain price and currency stability. It needs to be isolated from the government to apply the brakes when economies overheat due to huge budget spending.

A man walks past the Bank Indonesia headquarters in Jakarta on September 2. © Reuters

This is why Indonesia passed its Central Bank Law in 1999, in line with a global trend of the 1990s towards legal guarantees on the independence of central banks. Now Jakarta is starting to move in the opposite direction.

The impetus for the reversal comes from the growing coronavirus epidemic in the country. As of Wednesday, Indonesia had more than 340,000 cases of COVID-19 – the second highest in Southeast Asia, after the Philippines. Its death toll has reached 12,000, about twice as many as in the Philippines and more than in any other country in the region. With around 4,000 new cases a day, Indonesia’s health crisis shows no signs of slowing down.

After the country confirmed its first infection with COVID-19 in early March, the Widodo government initially avoided strict countermeasures for fear of slowing the economy. It wasn’t until April 10 that the government imposed a de facto lockdown. This delay, coupled with a rush to restart economic activity before the epidemic was brought under control, made the situation worse. What followed was the worst possible outcome: having to reimpose social restrictions in September after easing them in June.

The administration announced an emergency stimulus package worth Rs 695 trillion ($ 47 billion) in May to support the country’s economy. The problem is how to finance it.

The pandemic is sapping tax revenue in a country where tax collection rates are already low, exacerbating chronic budget deficits. In response, Jakarta temporarily eased its budget deficit ceiling to 3% of gross domestic product and opened up the possibility for the central bank to issue new currency to directly buy public debt.

This practice, known as debt monetization, is considered taboo in monetary policy because it allows governments to use central banks as ATMs. The concern is that this leads to lax fiscal discipline and a loss of confidence in the currency. Japanese law prohibits this practice.

The government and the Bank of Indonesia have set a ceiling of Rs 575 trillion for the subscription of zero-rated bonds as a special measure limited to the current fiscal year. But the economic crisis is only getting worse as Indonesia faces a long battle against the coronavirus. The proposed revisions to the central bank law are arguably an attempt to make an emergency measure permanent.

The Bank of Indonesia “has generated a great deal of credibility in its management of monetary policy over the past few years, when interest rates and currencies were subject to some volatility, even when decisions to raise rates. Interest has arisen as the election approaches, ”said Steve Cochrane, chief Asia-Pacific Economist at Moody’s. << The current agreement to share the debt burden between [Bank Indonesia] and the government is putting some of that in jeopardy, but the arrangement is supposed to be for a fixed amount and a fixed duration. "

Indonesia’s central bank enjoyed a reputation for reliability. When the International Monetary Fund assessed central bank independence on a scale of zero to one in 2007, Indonesia scored 0.63 – roughly the same as the United States and above 0, 38 in the UK and 0.13 in Japan.

Then President Suharto, right, accompanied by Vice President Try Sutrisno, greets a crowd of students at a ceremony celebrating the 51st anniversary of Indonesia’s independence in Jakarta on August 17, 1996. © Reuters

The Bank of Indonesia’s strong guarantee of independence in the 1999 law was born out of a desire not to repeat the failures under strongman Suharto’s three-decade rule until 1998.

Under Suharto’s regime, the governor of the central bank was appointed a member of the cabinet and removed by the president at his discretion. This governance model resulted in a bank that turned a blind eye to excessive government spending and an overheating economy. Many economists believe Indonesia’s problems contributed to the Asian financial crisis, which precipitated Suharto’s downfall.

The Central Bank Act 1999 stipulates that the Bank of Indonesia is a national institution and free from government intervention. The president can no longer dismiss the governor of the bank. This guarantee has been an inseparable part of the country’s transition from dictatorship to democracy.

But the proposed monetary council, led by the finance minister, would mark a return to a governance model of the Suharto era. In this regard, the revision of the central bank law risks reverting to authoritarianism.

This is not the only sign of slippage. A law amending the Corruption Eradication Commission, better known as KPK, was enacted in October last year after Widodo’s second term began.

The law actually undermines the KPK, which was designed to investigate corruption in a way that was not possible under the Suharto regime. Lawmakers passed the legislation on to parliament despite public opposition, while Widodo remained silent.

“Indonesia may have democratized, but the so-called ‘cost of democracy’ has been so great that things are not moving quickly,” said Yuri Sato, senior researcher at the Institute of Economics developing from the Japan Foreign Trade Organization. “Some people in the executive and legislative bodies seem to feel this and believe that governance will work best if power is concentrated to a certain extent rather than too dispersed.”

If Indonesia is a late comer to democracy, it is the leader of the emerging economies of Southeast Asia. As the saying goes, “wishes taken in a storm are quietly forgotten”, the country’s attachment to its values ​​now seems to be wavering.



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