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NEWS UPDATES Asean Affairs   30  December 2010

Stricter Forex rules to quell "Hot Money"

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Bank Indonesia (BI), Indonesia's central bank, plans to compel domestic lenders to increase their foreign exchange reserves deposited in it starting in March to rein in hot money that could threaten the country's economic stability.

"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 havoc 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.

Starting November 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.

Economists have hailed the move. "It is a positive step as it could reduce the cost of monetary operation,'' said Destry Damayanti, an economist at Mandiri Sekuritas in Jakarta.

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

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