JAKARTA -- Indonesia crossed the Rubicon earlier this year when its central bank became one of the first in the world to break the unwritten taboo of buying bonds directly from the government.
Now, Bank Indonesia has again been thrust into the spotlight, as lawmakers discuss proposals to amend the law governing the central bank that would potentially rid it of its independence -- a cornerstone of modern-day monetary policy.
The proposal in late August sent the rupiah, already the region's worst performing currency, plunging against the dollar. Economists were quick to raise concerns: "The fact that it is coming from the parliament, in our view, runs the risk of adding to market concerns that Bank Indonesia's independence is being undermined," Nomura said in a note.
The central bank's board of governors consists of six independent members, who are put forward by the president and voted on by parliament. The new proposal by a "panel of experts" consisting of current lawmakers seeks to give the government more influence by having two ministers join the board and vote in its monthly monetary policy meeting. The recommendation also calls for a creation of a "monetary council" led by the finance minister to supervise Bank Indonesia.
Central bank independence is seen as important as it insulates monetary policy from political interference. A nonindependent central bank could be used by politicians to fund excessive government spending to deliver short-term economic growth amid electoral pressure. Such a lack of fiscal discipline might then lead to economic instability and higher sovereign debt.
Having a cabinet member on a central bank board is not a new concept. In the Philippines, for example, one member must be a minister. Still, "the boundaries of must be clear," said Josua Pardede, an economist at Bank Permata. "If coordination is needed, [the existing] Financial System Stability Committee is sufficient to bridge this and should be strengthened. Monetary policy... must fully be in the hands of Bank Indonesia."
Bank Indonesia's independence first came into question in March, when President Joko Widodo signed a regulation that allowed it to purchase government bonds in the primary market. Then in July, the central bank and government agreed to a "burden-sharing" scheme under which Bank Indonesia purchased $397.6 trillion rupiah ($27 billion) of bonds directly from Jakarta's $40 billion fiscal deficit-financing scheme to combat COVID-19. All interest payments were to be returned to the government.
Some investor fears were assuaged by measures having a limited time frame -- purchases in the primary market will only be allowed until 2022, and both the government and Bank Indonesia have stressed the burden-sharing is a "one off."
But the proposed legal change seeks to put into law these measures as a permanent tool for Bank Indonesia.
The recommendation states the central bank may make primary market bond purchases "for monetary control operations and/or emergency financing facility," while a similar arrangement to the burden-sharing arrangement can be taken "under certain economic conditions." The proposal may also allow Bank Indonesia to provide temporary financing in the event of a government revenue shortfall.
The proposed changes are "potentially damaging to the reputation of central bank independence, which was crucial in soothing the investors when Bank Indonesia started to directly finance the ballooning fiscal deficit this year," said Sung Eun Jung, economist at Oxford Economics. "If such practice is no longer deemed to be temporary, credit rating agencies will also likely put Indonesia under greater scrutiny."
The members of the "panel of experts" who put forward the recommendations are unknown, as are their intentions. The plan, however, does follow the global trend of calls for more cooperation between fiscal and monetary policy.
Crucially, Widodo has made it clear his administration intends to keep central bank independence. While acknowledging that the government does not yet know the details of the recommendations, the president said in a meeting with foreign correspondents last week that "the government does not want Bank Indonesia's independence to change."
"The current condition of monetary monitoring is good," the president said.
Sri Mulyani Indrawati, the country's finance minister, said early this week that the proposals are "an initiative of the lawmakers" and the government "has not held any discussions yet" on the recommendations.
"The government recognizes that structuring and strengthening the financial system must prioritize the principles of good governance, a clear division of duties and responsibilities for each institution, as well as an adequate check-and-balance mechanism," she said.
Bank Indonesia declined to comment on the issue.
Any changes to Bank Indonesia law will take time. The proposal is in discussion in the parliament's legislative body, which will need to form a bill to hand to the House.
"Historically, any bill proposed by the House still has a long way before it is passed into law," said Satria Sambijantoro, economist at Bahana Sekuritas. "In most cases, the government normally comes out with its own version of the bill and the final law would include clauses deemed best by both the legislative and executive branches."
The government can also decide to reject the bill -- something economists at Nomura believe is needed to soothe market fears.
"More explicit statements from President Jokowi and even key parliament members to rule out the draft bill may be needed to assuage market concerns more permanently," they said. Unless announcements to dismiss the bill are made, the economists added, "there is a risk that market concerns over potential legislative changes initiated by parliament that compromise Bank Indonesia's independence could resurface."
Additional reporting by Ismi Damayanti and Bobby Nugroho