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

Less independent Bank Indonesia would return monetary policy to Suharto era

A woman wearing a protective face mask and shield walks past a banner showing a masked Indonesian President Joko Widodo promoting coronavirus awareness at Tanah Abang Station in Jakarta on Sept. 14.   © Reuters

BANGKOK -- While a so-called omnibus law has sparked ongoing protests in Indonesia, another move shows President Joko Widodo's government and the legislature trying to turn the clock backward to an earlier, less democratic time.

In early September, the parliament suddenly announced the start of deliberations on changes to the 1999 central bank law.

The proposal has three key points. The first is to delete language on the political independence of Bank Indonesia. The second calls for transferring monetary policy decisions from the central bank to a council chaired by the finance minister. Extending the central bank's mandate from price and exchange rate stability to economic growth and employment is the third point.

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

Responding to concerns from market participants, Finance Minister Sri Mulyani Indrawati pledged to respect Bank Indonesia's independence. But she did not deny the need for changes to the central bank law. The bill is expected to sail through the parliament, as the ruling coalition holds 70% of seats in the lower house.

"Now the house, seemingly with the government's support, intends to reduce the central bank's independence by requiring it to be more pro-growth in its monetary policy," professor Haryo Kuncoro, of Jakarta State University, wrote in a local newspaper.

Election-driven governments and legislatures, if left unchecked, tend to resort to expansionary fiscal policy and will go further by calling for easy-money measures to stimulate economic activity. This happens not only in authoritarian countries with inadequate check and balances, but also in democracies.

Monetary policy's job is to maintain price and currency stability. It needs to be isolated from the government to apply the brakes when economies overheat as the result of lavish fiscal spending.

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

That is why Indonesia adopted its central bank law in 1999, in line with a global trend in the 1990s toward 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 country's growing coronavirus outbreak. As of Wednesday, Indonesia had more than 340,000 cases of COVID-19 -- the second-largest number in Southeast Asia, after the Philippines. Its death toll topped 12,000 people, about twice as many as in the Philippines and more than any other country in the region. With about 4,000 new cases per day, Indonesia's health crisis shows no signs of abating.

After the country confirmed its first COVID-19 infection in early March, the Widodo government initially avoided strict countermeasures for fear of slowing the economy. It took until April 10 for the government to impose a de facto lockdown. This delay, coupled with a rush to restart economic activity before the outbreak was under control, worsened the situation. What followed was the worst-possible outcome: having to reimpose social restrictions in September after loosening them in June.

The administration announced an emergency package of stimulus measures worth 695 trillion rupiah ($47 billion) in May to prop up the nation's economy. The problem is how to fund it.

The pandemic is undercutting tax revenue in a country where tax collection rates are already low, adding to chronic fiscal deficits. In response, Jakarta has temporarily eased its budget deficit cap of 3% of gross domestic product and opened up the possibility of the central bank issuing new currency to directly buy government debt.

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

The government and Bank Indonesia set a cap of 575 trillion rupiah on underwriting zero-interest bonds as a special measure limited to the current fiscal year. But the economic crisis is only worsening 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.

Bank Indonesia "generated a lot of credibility in its management of monetary policy over the past several years when interest rates and foreign exchange were subject to some volatility, even when decisions to raise interest rates came as elections were approaching," said Steve Cochrane, chief Asia-Pacific economist at Moody's. "The current debt burden sharing arrangement between [Bank Indonesia] and government puts some of this at risk, but the arrangement is supposed to be for a fixed amount and a fixed time."

The Indonesian central bank used to enjoy a reputation for reliability. When the International Monetary Fund rated the independence of central banks on a scale of zero to one in 2007, Indonesia scored 0.63 -- roughly the same as the U.S. and higher than the U.K.'s 0.38 and Japan's 0.13.

Then President Suharto, right, accompanied by Vice President Try Sutrisno, waves to a crowd of students during a ceremony to celebrate the 51st anniversary of Indonesia's independence in Jakarta on Aug. 17, 1996.   © Reuters

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

Under the Suharto regime, the central bank governor was appointed as a cabinet member and dismissed 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 1999 central bank law states that Bank Indonesia is national institutional and free from government intervention. The president can no longer dismiss the bank's governor. This guarantee has been an inseparable part of the country's shift from dictatorship to democracy.

But the proposed monetary council, headed by the finance minister, would mark a return to a Suharto-era governance model. In this respect, revising the central bank law risks a backslide into authoritarianism.

This is not the only sign of slippage. A law to amend the Corruption Eradication Commission, better known as the KPK, was enacted in October last year following the start of Widodo's second term.

The law in effect undermines the KPK, which was designed to investigate graft in ways the were not possible under the Suharto regime. Lawmakers railroaded the legislation through the parliament despite public opposition, while Widodo kept silent.

"Indonesia may have democratized, but the so-called 'cost of democracy' has been so great that things do not advance promptly," said Yuri Sato, executive senior research fellow at the Institute of Developing Economies of the Japan External Trade Organization. "Some people in the executive and legislative bodies seem to feel this way and think that governance will work better if power is concentrated to some extent rather than dispersed too much."

While Indonesia is a late comer to democracy, it is the front-runner among emerging economies in Southeast Asia. Like the proverb "vows made in a storm are forgotten in the calm," the country's commitment to its values now seems to be wavering.

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