Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910500117024
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Post-crisis monetary and exchange rate policies in
Indonesia, Malaysia and Thailands
George Fane
To cite this article: George Fane (2005) Post-crisis monetary and exchange rate policies in
Indonesia, Malaysia and Thailands, Bulletin of Indonesian Economic Studies, 41:2, 175-195,
DOI: 10.1080/00074910500117024
To link to this article: http://dx.doi.org/10.1080/00074910500117024
Published online: 18 Jan 2007.
Submit your article to this journal
Article views: 115
View related articles
Citing articles: 6 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 19 January 2016, At: 19:47
BIESAug05
29/6/05
4:18 PM
Page 175
Bulletin of Indonesian Economic Studies, Vol. 41, No. 2, 2005: 175–95
POST-CRISIS MONETARY AND EXCHANGE RATE
POLICIES IN INDONESIA, MALAYSIA AND THAILAND
George Fane ∗
a
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Australian National University
This paper surveys the post-crisis monetary and exchange rate policies of Indonesia, Thailand and Malaysia. Malaysia has pegged the ringgit while Indonesia and
Thailand have adopted heavily managed exchange rates. Under their IMF programs, Thailand and Indonesia set base money targets, but Thailand has moved,
and Indonesia is now moving, to inflation targeting, using interest rates as the
short-term instrument. Malaysia also sets interest rates. The ability of the three central banks to set interest rates and also pursue an exchange rate target with an interest rate target has been bolstered by restrictions on the internationalisation of the
domestic currency. The three central banks have also had to sterilise the monetary
effects of their foreign exchange interventions. It is argued that inflation targeting
is now a good policy choice, but that a more freely floating exchange rate would be
better than sterilisation of balance of payments surpluses or deficits.
INTRODUCTION
The monetary and exchange rate responses of Indonesia, Thailand and Malaysia
to the dramatic speculative attacks on their currencies in 1997 were very different. Having sought and obtained the help of the IMF, Indonesia and Thailand
abandoned long-standing policies of pegging their currencies to baskets that
were overwhelmingly dominated by the dollar, and announced the adoption of
floating exchange rate regimes and restrictive monetary policies based on targets
for restraining the rate of growth of base money (M0).
In the first nine months of the 1997–98 crisis, Bank Indonesia (BI) completely
failed to meet the monetary targets announced in the Indonesian government’s
letters of intent (LOIs) to the IMF. This happened as a result of last-resort lending
to weak banks that was far in excess of the amount needed to meet the public’s
demand to convert deposits into cash (Fane and McLeod 1999: tables 2, 3 and 4;
Kenward forthcoming; McLeod 2003: 305–6; Djiwandono 2004: 65–6). In the second half of 1998, BI did achieve its base money targets. As a result, interest rates
α
∗ I am grateful for help from officials of the central banks of Indonesia, Malaysia and Thai-
land. I have also received many helpful comments from Stephen Grenville, Lloyd Kenward and Stephen Marks. The opinions expressed and any remaining errors are of course
my responsibility alone.
ISSN 0007-4918 print/ISSN 1472-7234 online/05/020175-21
DOI: 10.1080/00074910500117024
© 2005 Indonesia Project ANU
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
176
4:18 PM
Page 176
George Fane
and inflation both fell rapidly and the exchange rate appreciated.1 During the
remainder of the IMF program, the M0 targets were not always met, but they
were never again missed as badly as they had been before mid-1998.
Under Thailand’s Standby Agreement with the IMF, the Bank of Thailand
(BOT) allowed the exchange rate to float, and from 1997 until 2000 it targeted base
money for periods that ranged from three months to one year ahead. On a dayto-day basis, the BOT adjusted its net supply of liquidity to the interbank money
market with the aim of minimising fluctuations in short-term interest rates. The
BOT’s policy was to put upward pressure on interest rates if base money was running ahead of the medium-term targets and downward pressure on interest rates
if base money was below them. Although there were some substantial deviations
between the actual and targeted values of base money, the deviations mainly
involved base money being below the announced targets.
Malaysian policy makers initially hoped that they would avoid the crises that
overtook Thailand and Indonesia in the second half of 1997, and did not seek assistance from the IMF. In December 1997, the Malaysian finance minister, Dr Anwar
Ibrahim, introduced policies of fiscal and monetary restraint that were described
as ‘IMF policy without the IMF’; however, it seems that Prime Minister Mahathir
did not support these policies, and they were reversed over the next eight months
(Athukorala 2001: 65–6). A complete break with the IMF’s prescription for dealing
with the Asian crisis occurred in September 1998, when Malaysia adopted mildly
expansionary monetary and fiscal policies, pegged the currency at Rgt 3.80/$ and
severely tightened its capital account controls (Athukorala 2001: chapter 6).
During the course of the Asian crisis, all three central banks tightened the
measures designed to prevent the use of their currencies in international financial
markets. These measures involve making it illegal for residents to make domestic currency-denominated loans to non-residents.
In May 2000, the BOT moved away from targeting base money and began to
set short-term interest rates so as to achieve a medium-term inflation goal. Even
though its Standby Agreement with the IMF has now ended, BI continues to have
annual targets for M0. However, these targets are now merely one of a checklist
of variables that BI monitors when deciding how to set short-term interest rates.
BI has announced that it will adopt a similar inflation targeting regime to that of
Thailand and has taken some steps in this direction (Alamsyah et al. 2001).
Despite nominally operating floating exchange rate policies, both BOT and BI
intervene heavily in the foreign exchange market and have to sterilise the effects
of these interventions in the domestic money market in order to keep short-term
interest rates at their set levels.
Bank Negara Malaysia (BNM) has now removed its exchange controls, other
than those designed to prevent the use of the ringgit in offshore financial centres.
So far, it has continued to keep the ringgit pegged to the dollar, but it neverthe-
1 The
30-day interest rate on SBI (Sertifikat BI, certificates of deposit at BI) peaked at 70.4%
in August 1998 before falling to 35.5% in December 1998; by August 1999 it was down to
13.1% (CEIC Asia Database). Inflation fell rapidly and the exchange rate appreciated from
Rp 15,000 to Rp 7,500/$ in just over three months (McLeod 2003: 305–6).
BIESAug05
29/6/05
4:18 PM
Page 177
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
177
less also sets short-term interest rates and it too therefore has to sterilise the monetary effects of its exchange market interventions.
In the aftermath of the crisis, there has therefore been a considerable convergence in the policies of the three central banks. If BNM were to allow the ringgit
to float, while still intervening heavily in the foreign exchange market, and if both
BI and BNM were to set firm medium-term inflation goals, the remaining differences would be trivial.
The next section begins with a statistical summary of real growth, monetary
growth, inflation and interest rates in the three countries and then discusses inflation targeting. This policy, which has become increasingly popular with central
banks in both developed and developing countries, has been adopted by the BOT
and is in the course of being adopted by BI.2 The third section begins with a discussion of the decision by all three central banks to intervene actively in the foreign exchange market and to sterilise the monetary effects of such intervention in
the short-term money market. The ability of central banks to do this is bolstered
by restrictions on the internationalisation of the domestic currency. These restrictions are the focus of the remainder of the section. The fourth section deals with
the technical aspects of monetary policy in the three countries, and the final section summarises the similarities and differences among the policies of the three
central banks and suggests tentative appraisals of these policies.
POST-CRISIS MONETARY OUTCOMES AND STRATEGIES
Monetary Growth, Real Growth, Inflation and Interest Rates
Table 1 provides an overview of the evolution of the supply of base money and
of its velocity of circulation in the three countries since 1999. All the series are
indexed at 100 in 1999, but the qualitative results would not be greatly changed
by using 1998 or 2000 as the starting year.
Between 1999 and 2004, real GDP grew by 25% in Indonesia and by 28% in
both Malaysia and Thailand. In contrast to these fairly similar rates of real
growth, base money grew much faster in Indonesia (105%) than in Malaysia
(31%) or Thailand (51%). This large difference in monetary growth between Indonesia, on the one hand, and Malaysia or Thailand, on the other, was enough to
dwarf the changes in the velocity of circulation of base money, and inflation was
therefore much faster in Indonesia than in the other two countries. The much
steeper rise in the consumer price index (CPI) in Indonesia than in Malaysia or
Thailand (table 1) confirms the familiar finding that a large expansion in base
money relative to GDP is virtually guaranteed to produce rapid inflation. However, the changes in velocity of circulation of base money were also quite substantial. In Indonesia, it rose by 13% between 1999 and 2002, but this rise was largely
reversed over the next two years. In Malaysia, velocity rose by 15% between 1999
2 In
addition to Thailand, the countries to adopt inflation targeting include Australia,
Brazil, Canada, Chile, the Czech Republic, South Korea, New Zealand and the United
Kingdom.
BIESAug05
29/6/05
4:18 PM
Page 178
178
George Fane
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
TABLE 1 Base Money, Nominal GDP and Velocity of Base Money a
(1999 = 100)
1999
2000
2001
2002
2003
2004
Indonesia
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
119
104
105
126
106
139
116
109
153
110
153
129
114
173
113
171
138
119
190
111
205
146
125
211
103
Thailand
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
104
102
105
106
102
112
103
107
111
99
122
104
113
117
96
135
106
120
128
95
150
109
128
142
94
Malaysia
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
104
102
109
114
109
108
103
109
111
103
113
105
114
120
107
121
106
120
131
108
131
108
128
150
115
a Data
for base money (M0) are averages of the monthly figures; velocity of M0 is defined
as nominal GDP divided by M0.
Source: CEIC Asia Database.
and 2004, whereas in Thailand it fell by 6% over the same period.3 As a result,
although base money grew more rapidly in Thailand than in Malaysia, inflation
was faster in Malaysia than in Thailand.
Base money can be expressed as the sum of the net foreign assets (NFA) and
net domestic assets (NDA) of the central bank. This identity is used in figures 1,
2 and 3 to analyse the proximate sources of changes in the supply of base money
in the three countries. One striking feature of these charts is the strong upward
trend in NFA in all three countries. Whatever the central banks of Thailand and
Indonesia may say about floating their currencies, figures 1 and 2 show that they
have actually intervened heavily and systematically in the foreign exchange
market.
A second striking feature of figures 1, 2 and 3 is the extent to which, in each
case, NDA and NFA are mirror images of each other. This results from the cen3 The rise in velocity in Malaysia can be explained, at least in part, by the reduction in statu-
tory reserve requirements. Likewise, the fall of velocity in Indonesia in 2004 is associated
with an increase in statutory reserve requirements in that year. The (modest) fall in velocity in Thailand does not have any equally simple explanation.
BIESAug05
29/6/05
4:18 PM
Page 179
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
179
FIGURE 1 Indonesia: Sources of Growth of M0
(Rp trillion)
400
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
300
200
NFA
100
NDA
0
-100
-200
-300
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
FIGURE 2 Thailand: Sources of Growth of M0
(Baht billion)
2,500
2,000
NFA
1,500
NDA
1,000
500
0
-500
-1,000
-1,500
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
tral banks setting exogenous targets for both the exchange rate and the shortterm interest rate. Of course, BOT and BI have not pegged their currencies
rigidly to the dollar in the way that BNM has, but all three central banks have
regularly intervened in the foreign exchange market, and these interventions
BIESAug05
29/6/05
4:18 PM
Page 180
180
George Fane
FIGURE 3 Malaysia: Sources of Growth of M0
(Rgt billion)
300
NFA
200
NDA
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
100
0
-100
-200
-300
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
have normally involved purchasing foreign exchange to prevent the appreciation of the domestic currency. At the same time, all three central banks have also
intervened in the short-term money markets on a day-to-day basis to absorb
liquidity, or on rare occasions to inject it, so as to keep short-term rates at their
target levels. The combination of these two policies has meant that open market
purchases of securities by each central bank have been determined endogenously to sterilise most of the effects of its foreign exchange market interventions
on the supply of base money.4
Figure 4 plots the course of nominal interest rates in the three countries. Just as
a large and rapid increase in base money almost invariably leads to rapid inflation, so does rapid inflation almost invariably lead to high nominal interest rates.
Since inflation has been much higher in Indonesia than in Thailand and Malaysia,
it is therefore not surprising that nominal interest rates in Indonesia have been
much higher than those in the other two countries.
4 In the absence of any other changes, an exchange rate fluctuation causes equal and oppo-
site changes in NDA and NFA, leaving M0 unchanged. The reason for the change in the
domestic currency value of NFA is obvious; the equal and opposite change in NDA arises
because one of its negative components is the net wealth of the central bank in domestic
currency, which is directly affected by capital gains, or losses, on NFA. For this reason,
exchange rate fluctuations cause the charts to exaggerate the extent to which the central
banks have actually sterilised NFA. Without knowing the composition of NFA between
dollars, yen, euro and so forth, it is impossible to make accurate allowances for this effect.
BIESAug05
29/6/05
4:18 PM
Page 181
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
181
FIGURE 4 Interest Rates
(% per year)
20
16
12
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Indonesia: SBI 30 days
Malaysia: Interbank 1 week
8
Thailand: Repo 7 days
4
0
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
Inflation Targeting in Thailand and Indonesia
Thailand’s experience with inflation targeting is interesting because it offers an
example to the other countries in the region of a monetary strategy that has so far
worked well. BI has announced that it too intends to adopt inflation targeting, but
has not moved as far in this direction as Thailand has. Malaysia has pegged the
ringgit against the dollar, but is now facing growing pressures to revalue. If it
does so, it may well opt for a managed float, and it would then presumably look
at the Thai evidence on the efficacy of inflation targeting.
Although Thailand’s Standby Agreement with the IMF did not end until July
2003, the BOT’s stated medium-term target variable was changed from base
money to inflation in 2000. Under the new regime, the Monetary Policy Committee (MPC) of the BOT fixes short-term interest rates at the level that it thinks will
keep the ‘core’ inflation rate within the announced target range of zero to 3.5%
per year, and it has so far succeeded in achieving this goal. Core inflation is measured by excluding energy and raw food prices from the CPI, and calculating the
year-on-year percentage increase of the resulting index on a monthly basis. The
target range for core inflation applies to the average of the monthly figures for
each quarter.5
5 For
example, the average rate of core inflation in the last quarter of 2004 is defined as the
average of the rates of core inflation for October, November and December 2004, relative
to the same months in 2003. Since the monthly increases were 0.6% in each case, the average core inflation rate for the quarter was also 0.6%.
BIESAug05
29/6/05
4:18 PM
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
182
Page 182
George Fane
The MPC meets about once per month to set the 14-day repurchase (‘repo’)
rate.6 Under a 14-day repo contract, one party sells a high quality security, such
as a treasury bill, to another party, but makes a commitment to buy it back at a
slightly higher price after 14 days. In effect, the first party borrows from the second party using the high quality security as collateral. The interest rate on the
loan is determined by the difference between the sale and the repurchase price.
The MPC uses the repo rate to influence inflation, raising the interest rate to
choke off inflation if it appears to be too rapid and lowering the interest rate if
inflation would otherwise be negative. Because of the width of the target zone,
the MPC can also devote some attention to other factors, such as the strength of
real growth. So far, the MPC has been able to keep core inflation within the target
zone; admittedly, the zone is quite wide, but the MPC deserves credit for keeping
inflation low and for anticipating how inflation is likely to respond to its actions
and to other internal and external developments.
The reason given for the switch from targeting base money to targeting inflation was the claim that the relationship between base money and output growth
had become weaker than it used to be (Bank of Thailand 2004: 3). In fact, the case
for targeting M0 rests on there being a stable relationship between it and the level
of nominal GDP, or perhaps between it and the price level, rather than on there
being a stable relationship between it and output growth. Given this and given
that the BOT has not tried to demonstrate that there is a stable relationship
between core inflation and output growth, it seems likely that the reason for the
switch probably had more to do with changing fashions, in Thailand and elsewhere, on how best to operate monetary policy. The relative merits of the two
alternative nominal targets—inflation and M0—are discussed below. The new
policy has strong similarities with the approach pioneered by the Reserve Bank
of New Zealand (RBNZ), and explanations of the new policy on the BOT’s website explicitly compare it to that of the RBNZ.
When BI adopts inflation targeting, this will not mark a sharp break with what
has gone before, since the setting of base money targets was always intended to
be a means to controlling inflation, rather than an end in itself. Besides, tentative
versions of inflation targeting formed part of several of Indonesia’s LOIs to the
IMF. The January 1998 LOI dropped the base money target that had been part of
the original IMF package and announced that inflation would be kept to less than
20% in 1998. In the event, the CPI rose by 21% in just the first two months of 1998.
The LOI of April 1998 reinstated base money as the proximate target of monetary
policy; it discussed the likely future rate of inflation, without making it a target.
The LOI of July 1998 stated that ‘inflation is to be reduced to a single-digit annual
rate within no more than two years’. The LOI of January 2000 set base money targets that were designed to keep annual inflation below 5%. The actual CPI
increase between December 1999 and December 2000 was 9.3%. Following a further increase in inflation to 12.5% for the 12 months ending in December 2001, the
LOI of 13 December 2001 announced that the ‘strategic goal’ of monetary policy
6 Before
May 2001, the BOT’s lending rate was set by the Monetary Policy Board. Other
minor changes occurred at the same time as the change in the title from ‘Board’ to ‘Committee’.
BIESAug05
29/6/05
4:18 PM
Page 183
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
183
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
was to restore single-digit inflation by the end of 2002. The actual CPI increase
between December 2001 and December 2002 was 9.9%. In September 2004, the
governor of BI announced a policy of ‘low and stable inflation’ for the period
2005–08. He stated that senior staff at BI were working on the details of how this
is to be achieved, but at the time of writing (February 2005) these details have yet
to be announced (Bank Indonesia 2004).
THE PURSUIT OF ‘ACTIVE’ MONETARY AND EXCHANGE RATE
POLICIES AND THE NON-INTERNATIONALISATION OF
DOMESTIC CURRENCY
Combining Active Monetary Policy with Active Exchange Rate Policy
All three central banks have combined ‘active’ monetary policies with ‘active’
exchange rate policies. In the case of exchange rate policy, ‘active’ is used here to
mean that the central bank has either fixed the nominal exchange rate (Malaysia)
or intervened heavily in the foreign exchange market to manage a rate that is
described as floating. In the case of monetary policy, ‘active’ is used to mean that
the central bank sets the short-term interest rate in the domestic money market.
Under perfect capital mobility, a central bank would have to choose between
active monetary policy and active exchange rate policy. The ability of the three
central banks to pursue both policies, at least in the short term, is due partly to
the reluctance of non-residents to hold large open positions in any of the relevant
currencies and partly to controls in each country that restrict the ‘internationalisation’ of the domestic currency—that is, controls designed to insulate onshore
interest rates from offshore speculative pressures by preventing residents making
loans to non-residents that are denominated in the domestic currency, and by preventing the emergence of offshore markets in securities denominated in the
domestic currency.
With some exceptions, such as the speculative flurry against the rupiah in mid2004, most of these interventions have involved acquiring foreign exchange
reserves so as to prevent the appreciation of the real exchange rate—that is, to
prevent an increase in the ratio of the price of non-traded goods to the price of
traded goods—and thus raise the profitability of industries producing exports
and import-competing products.
Sterilising balance of payments surpluses to prevent exchange rate appreciation is of course what the Asian central banks did in the boom period that preceded the 1997 financial crisis, and it probably contributed to the occurrence of
the crisis. If, instead of sterilising a capital inflow, the central bank allows the
exchange rate to appreciate, the inflow would be self-correcting, because it would
depress the returns to domestic assets by driving up their domestic currency
prices and, a fortiori, their foreign currency prices. If the exchange rate is allowed
to float, a foreign capital inflow will reduce domestic interest rates. If the inflow
would have been $100 million at the initial level of interest rates, the final inflow
will be less than $100 million because of the fall in domestic interest rates; part of
this reduced amount will finance increased real investment and the rest will be
matched by higher non-resident holding of domestic private securities. If
instead, the exchange rate is held constant and the effects of the capital inflow on
the money supply are sterilised by the sale of short-term bills by the central bank,
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
184
4:18 PM
Page 184
George Fane
the domestic interest rate will not fall and the final inflow will be the initially
planned $100 million, not some lesser amount. Further, the whole of the $100 million will now go into increased non-resident holdings of official short-term bills
and real investment will not rise. Sterilisation therefore switches off the stabilising effects of a capital inflow on interest rates and investment. If the central bank
matches its short-term domestic currency-denominated liabilities with short-term
foreign currency-denominated assets, the reversal of the inflow would not be a
problem, provided that the authorities were willing to run down their foreign
currency-denominated assets in defence of the domestic currency, and provided
that a sudden capital outflow did not generate speculation against the domestic
currency. But since these conditions may not hold, managing the exchange rate
and sterilising the monetary effects of balance of payments surpluses is a dangerous policy.
Offshore Markets in Rupiah, Baht and Ringgit
The growth of offshore currency markets can occur as a result of globalisation,
but is often accelerated by attempts to escape from onshore financial regulations.
Both factors were important causes of the growth of the eurodollar market—the
largest of all offshore currency markets—and both were also important in the
growth of offshore markets in Asian currencies before 1997. Offshore markets in
rupiah, baht and ringgit existed in Singapore and in some other international
financial centres. International banks in these offshore centres were able to accept
deposits in ringgit, baht and rupiah and to engage in spot and swap transactions
between these currencies and the major international currencies, particularly the
dollar. Perhaps because of BNM’s relatively tight domestic financial controls, the
offshore ringgit market in Singapore was particularly large until BNM regulated
it out of existence in September 1998.
Foreign exchange swap contracts, and regulations designed to restrict the use
of such contracts, have been particularly important in offshore currency markets.
Box 1 explains the mechanics of these contracts.
Governments and central banks often view the internationalisation of their
currencies with hostility, since it reduces the effectiveness of their regulation of
the domestic financial system; it also weakens their control over interest and
exchange rates, by allowing speculation in offshore markets to have a direct
impact on domestic interest rates and the spot exchange rate—or on official
reserves, if the central bank intervenes to defend the spot exchange rate.
As an example of how offshore speculation can affect onshore interest rates,
consider an offshore speculator who does not hold rupiah but expects that the
rupiah will weaken sharply against the dollar. If correct, this speculator can make
a profit by borrowing in rupiah, selling the rupiah for dollars in the spot foreign
exchange market, and then buying dollar-denominated securities. The speculator
could achieve the same result by swapping dollars for rupiah, using the rupiah to
buy back dollars in the spot market and then making dollar-denominated loans.
Whether done directly, or indirectly via the swap market, these transactions
would put upward pressure on onshore rupiah interest rates and downward
pressure on the value of the rupiah. To resist these pressures without restricting
access to the spot market in foreign exchange, the Indonesian authorities would
have to make it illegal for residents to lend directly to non-residents in rupiah and
BIESAug05
29/6/05
4:18 PM
Page 185
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
185
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
BOX 1 THE MECHANICS OF FOREIGN EXCHANGE SWAPS
A foreign exchange swap has two parts. In the first part, the two parties to the contract exchange amounts of two currencies that have the same value in the spot market; in the second part, the initial exchange is reversed at a rate that reflects the
originally expected change in the spot exchange rate. As an illustration, consider a
swap between rupiah and dollars, on 1 January when the exchange rate in the spot
market is Rp 8,000/$. In the first part, the two contracting parties exchange amounts
of rupiah and dollars that have the same value in the spot market, for example Rp 8
billion and $1 million. In the second part, which might occur three months later, on
1 April, the initial swap is reversed, but at an exchange rate that reflects the difference between rupiah and dollar interest rates. If the interest rate for borrowing and
lending in rupiah is 12% per year, and therefore roughly 3% for three months, and
the interest rate for borrowing and lending in dollars is 4% per year, and therefore
roughly 1% for three months, the exchange rate for the second part of the transaction, the reversal of the original swap, will be about Rp 8,160/$, that is the initial
exchange rate scaled up by the 2% difference between the three-month interest rates
on rupiah and dollars. ‘Roughly’ and ‘about’ have been used because this numerical example uses simple interest and ignores the minor complications of compound
interest. The party that handed over Rp 8 billion in exchange for $1 million on 1 January will be returned about Rp 8.16 billion in exchange for $1 million on 1 April.
Restrictions on the ability of onshore banks to enter into swaps with nonresidents in which the onshore bank initially provides domestic currency in
exchange for foreign currency are an essential part of an exchange control system
that is designed to prevent the internationalisation of the domestic currency. The
reason is that such swaps effectively involve the onshore bank making a domestic
currency-denominated loan to the non-resident, matched by a foreign currencydenominated loan from the non-resident to the domestic bank.
they would also have to restrict indirect rupiah lending via the swap market. As
explained below, all three central banks have responded to the Asian crisis by
imposing and tightening such restrictions.
Restrictions on the Internationalisation of the Rupiah, Baht and Ringgit
Soon after the outbreak of the Asian crisis, BI issued a regulation to restrict indirect lending by onshore banks to non-residents via the swap market (Bank Indonesia 1998: 65). It further tightened its restrictions on the internationalisation of
the rupiah following the flurry of speculation that saw the dollar value of the
currency fall by 8% between April and June 2004.7 Then, in September 2004, BI
issued a new prudential regulation on the net open position (NOP) in foreign
exchange of the commercial banks—that is, the difference between the values of
7 The
rupiah weakened from Rp 8,661/$ in April 2004 to Rp 9,415/$ in June 2004 (CEIC
Asia Database).
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
186
4:18 PM
Page 186
George Fane
each bank’s foreign currency assets and liabilities, relative to their capital—that
has had the effect of further restricting their access to the swap market. Previously, each bank’s overall NOP had to be less than 20% of its capital, and this
requirement was monitored at the end of each day. Under the new regulations,
both the on-balance sheet NOP and the overall NOP, that is, the sum of the onbalance sheet NOP and the off-balance sheet NOP, must be less than 20% of capital, and this condition must be met at midday, as well as at the end of the day.
The new regulation has substantially hindered banks’ ability to trade in the
swap market. The reason follows from the fact that, as explained in box 1, a foreign exchange swap has two parts: in the first, currencies are swapped, in the second the original swap is reversed. Because of this reversal, the swap does not
change either party’s overall exposure to foreign exchange risk. An Indonesian
bank that swaps rupiah for dollars in the first part of the transaction incurs an
obligation to return dollars for rupiah in the second part that exactly offsets the
net open position that would be produced by the first part of the transaction, if it
were undertaken in isolation. A bank’s overall NOP is therefore unaffected by
swap market transactions, and these transactions were therefore not restricted by
Indonesia’s pre-September 2004 regulations on each bank’s overall NOP. Under
the new regulations, the initial exchange of currencies is recorded on-balance
sheet, but the offsetting commitment to reverse the swap is off-balance sheet. The
new regulations therefore prevent a swap market transaction that would cause
the bank’s net on-balance sheet open position to exceed 20% of its equity.
Policies to prevent the internationalisation of the baht have been part of the
BOT’s response to the Asian crisis. In January 1998, it imposed tight limits on
baht-denominated credit facilities provided by Thai financial institutions to nonresidents unless there was an underlying trade or investment activity in Thailand
(Bank of Thailand 2000), and these restrictions remain in place.
Even before the outbreak of the crisis, direct lending by Malaysian residents
to non-residents in ringgit had been prohibited by BNM’s exchange controls,
and in August 1997 BNM effectively banned indirect lending by setting very low
limits on the amounts of ringgit that onshore banks could offer to swap with
non-residents, unless there was an underlying real transaction, such as trade or
foreign direct investment. Then, as part of the exchange controls introduced by
Malaysia in September 1998, the offshore market in ringgit deposits was closed.
This was achieved by allowing holders of offshore ringgit deposits a grace
period of one month in which to repatriate their deposits to Malaysia, after
which it became illegal for onshore banks to accept inward transfers of ringgit
from offshore banks.
Costs and Benefits of Restricting
Internationalisation of the Domestic Currency
The advantage of allowing the domestic currency to be ‘internationalised’, as
Australia did when it abolished all exchange controls in 1983, is that this adds to
the liquidity of the domestic money market and of the forward and swap markets
in foreign exchange. The smaller the domestic financial system, the more important are these advantages. Allowing international banks to engage freely in the
swap and forward markets gives these markets, which are used by traders and
investors, as well as by speculators, much greater depth than they would have if
BIESAug05
29/6/05
4:18 PM
Page 187
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
187
restricted purely to onshore banks. Access to offshore markets in local currency
adds to the liquidity of the onshore banks in the onshore money market. If these
banks have shortages or surpluses of liquidity in domestic currency, they can borrow from, or lend to, offshore banks.
The disadvantage of allowing the domestic currency to be internationalised is,
of course, that it means that offshore speculative pressures are directly transmitted
to onshore interest rates and the onshore foreign exchange market. But there are
other, more effective, ways to avoid the costs of destabilising speculation, without
forgoing the benefits of internationalisation of the domestic currency. These
include giving the central bank independence to pursue a credible target, such as
low inflation, or slow monetary growth; encouraging the entry of international
banks; improving bankruptcy laws (since the financial system cannot work efficiently if sanctions against defaulters are ineffective); and raising the capital adequacy ratios of banks and other financial institutions. Since it would be hard to
guarantee that even these policies would be completely effective, and since the
costs of the financial crisis of 1997–98 proved to be very high, it is not surprising
that all three countries maintain tight restrictions on the internationalisation of
their currency. While this safety first approach can be defended, the three governments can be criticised for not also moving much more vigorously to implement
the first best policies, listed above, for reducing financial sector vulnerability.
TECHNICAL ASPECTS OF MONETARY POLICY
Monetary Policy Techniques: Indonesia
BI uses two instruments for conducting open market operations, FASBI and SBI.
FASBI (Fasilitas Simpanan BI, BI Deposit Facility) is a term deposit facility. At
present all FASBI deposits are accepted for a term of seven days. SBI are certificates of deposit that are currently issued for maturities of one month and three
months.8 By accepting all deposits offered at the FASBI rate and by adjusting the
outstanding volumes of one-month and three-month SBIs, BI can control shortterm interest rates. Neither FASBI nor SBI is part of base money, so when banks
move their funds from vault cash or excess reserves to either of these instruments,
NDA and base money are both reduced by the corresponding amount.
FASBI grew out of BI’s response to the recent Indonesian banking crisis (Kenward forthcoming). Beginning in September 1997, there was a massive drain on
deposits in the troubled private banks as investors moved funds to the state
banks. Even though the state banks ended up making larger losses, relative to
their share of deposits, than the private banks, depositors correctly perceived that
they were backed by implicit government guarantees. This transfer of deposits in
late 1997 and early 1998 meant that the troubled private banks were experiencing
an acute liquidity crisis at the same time that most state banks had excess liquidity. As a result, the interest rates paid by the strongest and weakest Indonesian
banks on interbank loans regularly differed by more than 100 percentage points:
while the strongest banks could borrow at 40–50%, the weakest had to pay 150%
or more (Bank Indonesia 1999: 62).
8 SBI
with six months to maturity were discontinued in 1999.
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
188
4:18 PM
Page 188
George Fane
BI responded to the switching of deposits from weak private banks to state
banks by introducing the deposit facility that later became known as FASBI. This
facility offered interest rates that were only slightly below the SBI rate in order to
attract deposits from the strong banks to which depositors fled when they feared
that weaker banks would fail. BI then lent these funds back to the weak banks in
the form of last-resort loans. The enormous losses that resulted from BI’s lastresort lending during the crisis (Frécaut 2004) show that it cannot be justified in
terms of the Bagehot-type recommendation that last-resort loans should be given
freely against good collateral (Bagehot 1920: 164).
Since FASBI deposits are issued for shorter periods than SBI, but are also promises by BI to pay fixed rupiah amounts, they are essentially the same as shortdated SBI. However, whereas SBI are issued at monthly auctions, the FASBI
facility is permanently open and banks can deposit as much or as little as they
wish at the rate set by BI, which at the time of writing is 7%. Because the banks
are not rationed at the SBI auctions, or in deciding how much FASBI to hold, the
two rates are never far apart. The one-month SBI rate is generally about 20 to 50
basis points (0.20 to 0.50 percentage points per year) above the FASBI rate, in
compensation for the greater liquidity of FASBI, but the exact difference depends
on expectations about changes in short-term interest rates.
The regulations that introduced FASBI provided for the possibility of BI offering to accept deposits for terms of up to 14 days. In the event, BI has never
accepted FASBI deposits for terms of more than seven days. It has usually offered
seven-day deposits, and initially it also offered one-day deposits, with rates that
varied according to whether the deposits were made in the morning or afternoon
trading sessions. Before June 2004, the overnight FASBI rate set a floor on the
overnight rate in the interbank money market, since banks would never lend to
each other at a lower rate than that offered by BI. However, in June 2004, BI began
to ration the amount of overnight FASBI that it would accept. The reason seems
to have been its reluctance to pay interest on deposits whose maturities are so
short that they do little to reduce the liquidity of the banking system. In January
2005, BI took this reasoning a step further and stopped accepting overnight FASBI
altogether. The situation at the time of writing was that only seven-day FASBI
were available, and there was no rationing of banks at the 7% rate set by BI.
If there were a deep secondary market in SBI, BI could trade in it to set oneweek interest rates. In practice this market is thin, and BI therefore sets this interest rate directly using FASBI, which offers some extra flexibility that the SBI
system does not possess. Of course the fact that BI operates in this way exacerbates the thinness of the SBI secondary market.
Monetary Policy Techniques: Thailand
The BOT’s primary operating instrument is the 14-day repurchase, or ‘repo’, rate.
The Monetary Policy Committee of the BOT meets about every six weeks to
announce the Bank’s ‘policy rate’, which is its target for the 14-day repo rate.
These announcements generally report the latest data on core inflation, and discuss expected economic developments in the coming year. This background
information is then used to justify the MPC’s choice of policy rate.
To implement the MPC’s decision, the BOT operates in two separate but
closely connected repo markets, the bilateral market and the BOT-operated mar-
BIESAug05
29/6/05
4:18 PM
Page 189
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
189
ket. Trading in the bilateral market is usually conducted once or twice per fortnight. This trading involves the sale by the BOT, under repurchase agreements, of
government securities to nine authorised dealers. The BOT indicates the amount
of liquidity that it intends to absorb and invites tenders from these dealers at various maturities, ranging from one day to one month. Recently, about half of the
volume traded has been for one day and the next most important maturity is 14
days. Some trading takes place at seven days, but only very little is traded for one
month. The BOT does not make a commitment on the total volume to be tendered. Rather, it adjusts this in the light of the bids to ensure that the average
accepted rates are very close to the policy rate. In the case of the 14-day tenders,
all bids must be at the policy rate, but bidders do not necessarily receive the full
amount for which they bid. The BOT decides how much to accept and apportions
the total among the dealers in proportion to their bids.
The BOT-operated repo market is open for one hour on each trading day.
Between 40 and 50 institutions are eligible to bid in this market. These eligible
institutions include large state-owned enterprises as well as banks and other
financial institutions. Buy and sell bids are submitted to the BOT, which matches
them and charges a small commission. As well as operating this market, the BOT
trades in it on its own account, using it to absorb or inject whatever liquidity is
needed to keep the 14-day rate close to the policy rate. The authorised dealers
use the BOT-operated market to adjust the positions taken up in the bilateral
market.
At the end of the day, banks with a shortage of liquidity can borrow from the
BOT at the policy rate plus 1.5%, using government securities as collateral. Those
with surplus liquidity can only leave it in their current accounts at the BOT. Since
these accounts do not bear interest, banks try to operate on a very small margin
of excess liquidity, and the bulk of the funds in their current accounts is there to
satisfy statutory reserve requirements. The BOT does have provisions for allowing banks with current account deposits in excess of their statutory requirements
to obtain a ‘credit’ against their future statutory requirements; that is, if they held
more than the required amount of reserves in one month, they can hold less than
the required amount in the next. Currently, the statutory reserve requirement is
1% of customers’ deposits. There is also a requirement that banks keep liquid
assets of at least 6% of customers’ deposits. Liquid assets are defined to include
current accounts at the BOT (although the required reserves are not really liquid),
vault cash and government securities. At the time of writing, banks have large
holdings of government securities and the demand for bank loans is low. As a
result, the liquid assets requirement is not binding and banks hold well in excess
of the 6% minimum.
Since lending to a central bank in its own currency is essentially risk-free, the
BOT does not really need to provide collateral for its borrowings from the financial system. Its reason for borrowing via repos, rather than employing a ‘pure
borrowing’ facility like BI’s FASBI, is that the collateral that it provides to the
institutions that lend to it can be used by these lenders as collateral for their own
borrowing, if the need arises. This deepens the market in government paper and
gives the lending institutions more flexibility than they would have if their lending was in the form of a non-transferable term deposit at the BOT. This has the
advantage for the BOT that financial institutions are willing to accept slightly
BIESAug05
29/6/05
4:18 PM
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
190
Page 190
George Fane
lower interest rates than the BOT would have to pay if it simply offered term
deposit facilities.
Although the bulk of the BOT’s open market operations are done in the repo
market, it does sometimes purchase government securities outright. Since one of
its long-term goals is to build up its portfolio of government securities, it does not
generally engage in outright sales of them, and since most of its monetary operations are intended to absorb liquidity rather than inject it, its outright purchases
are infrequent and generally small. It can also use the swap market to affect
domestic monetary conditions. For example, it can absorb domestic liquidity by
swapping the foreign currency-denominated assets that it holds in international
financial centres for baht.
Monetary Policy Techniques: Malaysia
BNM currently faces the problem of absorbing the large capital inflows that
Malaysia is experiencing as a result of the widespread expectation that its temporarily fixed exchange rate may soon be revalued upwards relative to the dollar, and almost certainly will not be devalued in the near future. The special
features of BNM’s monetary operations that distinguish them from those of BI
and the BOT are due to the fact that it is constrained in the ways that it can
absorb liquidity. BNM’s own holdings of Malaysian Government Treasury Bills
(MGTBs) or other Malaysian government securities are too small to absorb more
than a limited amount of the capital inflows of the recent past.9 Most of the
Malaysian government’s outstanding securities are held by ‘captive institutions’, such as insurance companies and the Employee Provident Fund (EPF),
which are legally required to invest in government securities. At the same time,
the Central Bank of Malaysia Act of 1958 fixes the maximum amount of BNM
paper that can be issued relative to its capital, and this limit is now binding. As
a result of this legal constraint, the Rgt 17 billion of Bank Negara paper now outstanding can be rolled over, but can only be increased in proportion to increases
in BNM’s capital.
As a result of the constraints described above, BNM’s monetary operations
mainly involve direct borrowing from the banks and other financial institutions
in the form of deposits. Each morning, BNM announces a daily tender at which
the banks bid for the right to place short-term deposits at BNM at rates that are
usually very close to the ‘overnight policy rate’ (OP
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Post-crisis monetary and exchange rate policies in
Indonesia, Malaysia and Thailands
George Fane
To cite this article: George Fane (2005) Post-crisis monetary and exchange rate policies in
Indonesia, Malaysia and Thailands, Bulletin of Indonesian Economic Studies, 41:2, 175-195,
DOI: 10.1080/00074910500117024
To link to this article: http://dx.doi.org/10.1080/00074910500117024
Published online: 18 Jan 2007.
Submit your article to this journal
Article views: 115
View related articles
Citing articles: 6 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 19 January 2016, At: 19:47
BIESAug05
29/6/05
4:18 PM
Page 175
Bulletin of Indonesian Economic Studies, Vol. 41, No. 2, 2005: 175–95
POST-CRISIS MONETARY AND EXCHANGE RATE
POLICIES IN INDONESIA, MALAYSIA AND THAILAND
George Fane ∗
a
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Australian National University
This paper surveys the post-crisis monetary and exchange rate policies of Indonesia, Thailand and Malaysia. Malaysia has pegged the ringgit while Indonesia and
Thailand have adopted heavily managed exchange rates. Under their IMF programs, Thailand and Indonesia set base money targets, but Thailand has moved,
and Indonesia is now moving, to inflation targeting, using interest rates as the
short-term instrument. Malaysia also sets interest rates. The ability of the three central banks to set interest rates and also pursue an exchange rate target with an interest rate target has been bolstered by restrictions on the internationalisation of the
domestic currency. The three central banks have also had to sterilise the monetary
effects of their foreign exchange interventions. It is argued that inflation targeting
is now a good policy choice, but that a more freely floating exchange rate would be
better than sterilisation of balance of payments surpluses or deficits.
INTRODUCTION
The monetary and exchange rate responses of Indonesia, Thailand and Malaysia
to the dramatic speculative attacks on their currencies in 1997 were very different. Having sought and obtained the help of the IMF, Indonesia and Thailand
abandoned long-standing policies of pegging their currencies to baskets that
were overwhelmingly dominated by the dollar, and announced the adoption of
floating exchange rate regimes and restrictive monetary policies based on targets
for restraining the rate of growth of base money (M0).
In the first nine months of the 1997–98 crisis, Bank Indonesia (BI) completely
failed to meet the monetary targets announced in the Indonesian government’s
letters of intent (LOIs) to the IMF. This happened as a result of last-resort lending
to weak banks that was far in excess of the amount needed to meet the public’s
demand to convert deposits into cash (Fane and McLeod 1999: tables 2, 3 and 4;
Kenward forthcoming; McLeod 2003: 305–6; Djiwandono 2004: 65–6). In the second half of 1998, BI did achieve its base money targets. As a result, interest rates
α
∗ I am grateful for help from officials of the central banks of Indonesia, Malaysia and Thai-
land. I have also received many helpful comments from Stephen Grenville, Lloyd Kenward and Stephen Marks. The opinions expressed and any remaining errors are of course
my responsibility alone.
ISSN 0007-4918 print/ISSN 1472-7234 online/05/020175-21
DOI: 10.1080/00074910500117024
© 2005 Indonesia Project ANU
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
176
4:18 PM
Page 176
George Fane
and inflation both fell rapidly and the exchange rate appreciated.1 During the
remainder of the IMF program, the M0 targets were not always met, but they
were never again missed as badly as they had been before mid-1998.
Under Thailand’s Standby Agreement with the IMF, the Bank of Thailand
(BOT) allowed the exchange rate to float, and from 1997 until 2000 it targeted base
money for periods that ranged from three months to one year ahead. On a dayto-day basis, the BOT adjusted its net supply of liquidity to the interbank money
market with the aim of minimising fluctuations in short-term interest rates. The
BOT’s policy was to put upward pressure on interest rates if base money was running ahead of the medium-term targets and downward pressure on interest rates
if base money was below them. Although there were some substantial deviations
between the actual and targeted values of base money, the deviations mainly
involved base money being below the announced targets.
Malaysian policy makers initially hoped that they would avoid the crises that
overtook Thailand and Indonesia in the second half of 1997, and did not seek assistance from the IMF. In December 1997, the Malaysian finance minister, Dr Anwar
Ibrahim, introduced policies of fiscal and monetary restraint that were described
as ‘IMF policy without the IMF’; however, it seems that Prime Minister Mahathir
did not support these policies, and they were reversed over the next eight months
(Athukorala 2001: 65–6). A complete break with the IMF’s prescription for dealing
with the Asian crisis occurred in September 1998, when Malaysia adopted mildly
expansionary monetary and fiscal policies, pegged the currency at Rgt 3.80/$ and
severely tightened its capital account controls (Athukorala 2001: chapter 6).
During the course of the Asian crisis, all three central banks tightened the
measures designed to prevent the use of their currencies in international financial
markets. These measures involve making it illegal for residents to make domestic currency-denominated loans to non-residents.
In May 2000, the BOT moved away from targeting base money and began to
set short-term interest rates so as to achieve a medium-term inflation goal. Even
though its Standby Agreement with the IMF has now ended, BI continues to have
annual targets for M0. However, these targets are now merely one of a checklist
of variables that BI monitors when deciding how to set short-term interest rates.
BI has announced that it will adopt a similar inflation targeting regime to that of
Thailand and has taken some steps in this direction (Alamsyah et al. 2001).
Despite nominally operating floating exchange rate policies, both BOT and BI
intervene heavily in the foreign exchange market and have to sterilise the effects
of these interventions in the domestic money market in order to keep short-term
interest rates at their set levels.
Bank Negara Malaysia (BNM) has now removed its exchange controls, other
than those designed to prevent the use of the ringgit in offshore financial centres.
So far, it has continued to keep the ringgit pegged to the dollar, but it neverthe-
1 The
30-day interest rate on SBI (Sertifikat BI, certificates of deposit at BI) peaked at 70.4%
in August 1998 before falling to 35.5% in December 1998; by August 1999 it was down to
13.1% (CEIC Asia Database). Inflation fell rapidly and the exchange rate appreciated from
Rp 15,000 to Rp 7,500/$ in just over three months (McLeod 2003: 305–6).
BIESAug05
29/6/05
4:18 PM
Page 177
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
177
less also sets short-term interest rates and it too therefore has to sterilise the monetary effects of its exchange market interventions.
In the aftermath of the crisis, there has therefore been a considerable convergence in the policies of the three central banks. If BNM were to allow the ringgit
to float, while still intervening heavily in the foreign exchange market, and if both
BI and BNM were to set firm medium-term inflation goals, the remaining differences would be trivial.
The next section begins with a statistical summary of real growth, monetary
growth, inflation and interest rates in the three countries and then discusses inflation targeting. This policy, which has become increasingly popular with central
banks in both developed and developing countries, has been adopted by the BOT
and is in the course of being adopted by BI.2 The third section begins with a discussion of the decision by all three central banks to intervene actively in the foreign exchange market and to sterilise the monetary effects of such intervention in
the short-term money market. The ability of central banks to do this is bolstered
by restrictions on the internationalisation of the domestic currency. These restrictions are the focus of the remainder of the section. The fourth section deals with
the technical aspects of monetary policy in the three countries, and the final section summarises the similarities and differences among the policies of the three
central banks and suggests tentative appraisals of these policies.
POST-CRISIS MONETARY OUTCOMES AND STRATEGIES
Monetary Growth, Real Growth, Inflation and Interest Rates
Table 1 provides an overview of the evolution of the supply of base money and
of its velocity of circulation in the three countries since 1999. All the series are
indexed at 100 in 1999, but the qualitative results would not be greatly changed
by using 1998 or 2000 as the starting year.
Between 1999 and 2004, real GDP grew by 25% in Indonesia and by 28% in
both Malaysia and Thailand. In contrast to these fairly similar rates of real
growth, base money grew much faster in Indonesia (105%) than in Malaysia
(31%) or Thailand (51%). This large difference in monetary growth between Indonesia, on the one hand, and Malaysia or Thailand, on the other, was enough to
dwarf the changes in the velocity of circulation of base money, and inflation was
therefore much faster in Indonesia than in the other two countries. The much
steeper rise in the consumer price index (CPI) in Indonesia than in Malaysia or
Thailand (table 1) confirms the familiar finding that a large expansion in base
money relative to GDP is virtually guaranteed to produce rapid inflation. However, the changes in velocity of circulation of base money were also quite substantial. In Indonesia, it rose by 13% between 1999 and 2002, but this rise was largely
reversed over the next two years. In Malaysia, velocity rose by 15% between 1999
2 In
addition to Thailand, the countries to adopt inflation targeting include Australia,
Brazil, Canada, Chile, the Czech Republic, South Korea, New Zealand and the United
Kingdom.
BIESAug05
29/6/05
4:18 PM
Page 178
178
George Fane
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
TABLE 1 Base Money, Nominal GDP and Velocity of Base Money a
(1999 = 100)
1999
2000
2001
2002
2003
2004
Indonesia
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
119
104
105
126
106
139
116
109
153
110
153
129
114
173
113
171
138
119
190
111
205
146
125
211
103
Thailand
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
104
102
105
106
102
112
103
107
111
99
122
104
113
117
96
135
106
120
128
95
150
109
128
142
94
Malaysia
Base money (M0)
CPI
Real GDP
Nominal GDP
Velocity of M0
100
100
100
100
100
104
102
109
114
109
108
103
109
111
103
113
105
114
120
107
121
106
120
131
108
131
108
128
150
115
a Data
for base money (M0) are averages of the monthly figures; velocity of M0 is defined
as nominal GDP divided by M0.
Source: CEIC Asia Database.
and 2004, whereas in Thailand it fell by 6% over the same period.3 As a result,
although base money grew more rapidly in Thailand than in Malaysia, inflation
was faster in Malaysia than in Thailand.
Base money can be expressed as the sum of the net foreign assets (NFA) and
net domestic assets (NDA) of the central bank. This identity is used in figures 1,
2 and 3 to analyse the proximate sources of changes in the supply of base money
in the three countries. One striking feature of these charts is the strong upward
trend in NFA in all three countries. Whatever the central banks of Thailand and
Indonesia may say about floating their currencies, figures 1 and 2 show that they
have actually intervened heavily and systematically in the foreign exchange
market.
A second striking feature of figures 1, 2 and 3 is the extent to which, in each
case, NDA and NFA are mirror images of each other. This results from the cen3 The rise in velocity in Malaysia can be explained, at least in part, by the reduction in statu-
tory reserve requirements. Likewise, the fall of velocity in Indonesia in 2004 is associated
with an increase in statutory reserve requirements in that year. The (modest) fall in velocity in Thailand does not have any equally simple explanation.
BIESAug05
29/6/05
4:18 PM
Page 179
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
179
FIGURE 1 Indonesia: Sources of Growth of M0
(Rp trillion)
400
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
300
200
NFA
100
NDA
0
-100
-200
-300
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
FIGURE 2 Thailand: Sources of Growth of M0
(Baht billion)
2,500
2,000
NFA
1,500
NDA
1,000
500
0
-500
-1,000
-1,500
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
tral banks setting exogenous targets for both the exchange rate and the shortterm interest rate. Of course, BOT and BI have not pegged their currencies
rigidly to the dollar in the way that BNM has, but all three central banks have
regularly intervened in the foreign exchange market, and these interventions
BIESAug05
29/6/05
4:18 PM
Page 180
180
George Fane
FIGURE 3 Malaysia: Sources of Growth of M0
(Rgt billion)
300
NFA
200
NDA
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
100
0
-100
-200
-300
Jun–99
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
have normally involved purchasing foreign exchange to prevent the appreciation of the domestic currency. At the same time, all three central banks have also
intervened in the short-term money markets on a day-to-day basis to absorb
liquidity, or on rare occasions to inject it, so as to keep short-term rates at their
target levels. The combination of these two policies has meant that open market
purchases of securities by each central bank have been determined endogenously to sterilise most of the effects of its foreign exchange market interventions
on the supply of base money.4
Figure 4 plots the course of nominal interest rates in the three countries. Just as
a large and rapid increase in base money almost invariably leads to rapid inflation, so does rapid inflation almost invariably lead to high nominal interest rates.
Since inflation has been much higher in Indonesia than in Thailand and Malaysia,
it is therefore not surprising that nominal interest rates in Indonesia have been
much higher than those in the other two countries.
4 In the absence of any other changes, an exchange rate fluctuation causes equal and oppo-
site changes in NDA and NFA, leaving M0 unchanged. The reason for the change in the
domestic currency value of NFA is obvious; the equal and opposite change in NDA arises
because one of its negative components is the net wealth of the central bank in domestic
currency, which is directly affected by capital gains, or losses, on NFA. For this reason,
exchange rate fluctuations cause the charts to exaggerate the extent to which the central
banks have actually sterilised NFA. Without knowing the composition of NFA between
dollars, yen, euro and so forth, it is impossible to make accurate allowances for this effect.
BIESAug05
29/6/05
4:18 PM
Page 181
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
181
FIGURE 4 Interest Rates
(% per year)
20
16
12
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Indonesia: SBI 30 days
Malaysia: Interbank 1 week
8
Thailand: Repo 7 days
4
0
Jun–00
Jun–01
Jun–02
Jun–03
Jun–04
Source: CEIC Asia Database.
Inflation Targeting in Thailand and Indonesia
Thailand’s experience with inflation targeting is interesting because it offers an
example to the other countries in the region of a monetary strategy that has so far
worked well. BI has announced that it too intends to adopt inflation targeting, but
has not moved as far in this direction as Thailand has. Malaysia has pegged the
ringgit against the dollar, but is now facing growing pressures to revalue. If it
does so, it may well opt for a managed float, and it would then presumably look
at the Thai evidence on the efficacy of inflation targeting.
Although Thailand’s Standby Agreement with the IMF did not end until July
2003, the BOT’s stated medium-term target variable was changed from base
money to inflation in 2000. Under the new regime, the Monetary Policy Committee (MPC) of the BOT fixes short-term interest rates at the level that it thinks will
keep the ‘core’ inflation rate within the announced target range of zero to 3.5%
per year, and it has so far succeeded in achieving this goal. Core inflation is measured by excluding energy and raw food prices from the CPI, and calculating the
year-on-year percentage increase of the resulting index on a monthly basis. The
target range for core inflation applies to the average of the monthly figures for
each quarter.5
5 For
example, the average rate of core inflation in the last quarter of 2004 is defined as the
average of the rates of core inflation for October, November and December 2004, relative
to the same months in 2003. Since the monthly increases were 0.6% in each case, the average core inflation rate for the quarter was also 0.6%.
BIESAug05
29/6/05
4:18 PM
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
182
Page 182
George Fane
The MPC meets about once per month to set the 14-day repurchase (‘repo’)
rate.6 Under a 14-day repo contract, one party sells a high quality security, such
as a treasury bill, to another party, but makes a commitment to buy it back at a
slightly higher price after 14 days. In effect, the first party borrows from the second party using the high quality security as collateral. The interest rate on the
loan is determined by the difference between the sale and the repurchase price.
The MPC uses the repo rate to influence inflation, raising the interest rate to
choke off inflation if it appears to be too rapid and lowering the interest rate if
inflation would otherwise be negative. Because of the width of the target zone,
the MPC can also devote some attention to other factors, such as the strength of
real growth. So far, the MPC has been able to keep core inflation within the target
zone; admittedly, the zone is quite wide, but the MPC deserves credit for keeping
inflation low and for anticipating how inflation is likely to respond to its actions
and to other internal and external developments.
The reason given for the switch from targeting base money to targeting inflation was the claim that the relationship between base money and output growth
had become weaker than it used to be (Bank of Thailand 2004: 3). In fact, the case
for targeting M0 rests on there being a stable relationship between it and the level
of nominal GDP, or perhaps between it and the price level, rather than on there
being a stable relationship between it and output growth. Given this and given
that the BOT has not tried to demonstrate that there is a stable relationship
between core inflation and output growth, it seems likely that the reason for the
switch probably had more to do with changing fashions, in Thailand and elsewhere, on how best to operate monetary policy. The relative merits of the two
alternative nominal targets—inflation and M0—are discussed below. The new
policy has strong similarities with the approach pioneered by the Reserve Bank
of New Zealand (RBNZ), and explanations of the new policy on the BOT’s website explicitly compare it to that of the RBNZ.
When BI adopts inflation targeting, this will not mark a sharp break with what
has gone before, since the setting of base money targets was always intended to
be a means to controlling inflation, rather than an end in itself. Besides, tentative
versions of inflation targeting formed part of several of Indonesia’s LOIs to the
IMF. The January 1998 LOI dropped the base money target that had been part of
the original IMF package and announced that inflation would be kept to less than
20% in 1998. In the event, the CPI rose by 21% in just the first two months of 1998.
The LOI of April 1998 reinstated base money as the proximate target of monetary
policy; it discussed the likely future rate of inflation, without making it a target.
The LOI of July 1998 stated that ‘inflation is to be reduced to a single-digit annual
rate within no more than two years’. The LOI of January 2000 set base money targets that were designed to keep annual inflation below 5%. The actual CPI
increase between December 1999 and December 2000 was 9.3%. Following a further increase in inflation to 12.5% for the 12 months ending in December 2001, the
LOI of 13 December 2001 announced that the ‘strategic goal’ of monetary policy
6 Before
May 2001, the BOT’s lending rate was set by the Monetary Policy Board. Other
minor changes occurred at the same time as the change in the title from ‘Board’ to ‘Committee’.
BIESAug05
29/6/05
4:18 PM
Page 183
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
183
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
was to restore single-digit inflation by the end of 2002. The actual CPI increase
between December 2001 and December 2002 was 9.9%. In September 2004, the
governor of BI announced a policy of ‘low and stable inflation’ for the period
2005–08. He stated that senior staff at BI were working on the details of how this
is to be achieved, but at the time of writing (February 2005) these details have yet
to be announced (Bank Indonesia 2004).
THE PURSUIT OF ‘ACTIVE’ MONETARY AND EXCHANGE RATE
POLICIES AND THE NON-INTERNATIONALISATION OF
DOMESTIC CURRENCY
Combining Active Monetary Policy with Active Exchange Rate Policy
All three central banks have combined ‘active’ monetary policies with ‘active’
exchange rate policies. In the case of exchange rate policy, ‘active’ is used here to
mean that the central bank has either fixed the nominal exchange rate (Malaysia)
or intervened heavily in the foreign exchange market to manage a rate that is
described as floating. In the case of monetary policy, ‘active’ is used to mean that
the central bank sets the short-term interest rate in the domestic money market.
Under perfect capital mobility, a central bank would have to choose between
active monetary policy and active exchange rate policy. The ability of the three
central banks to pursue both policies, at least in the short term, is due partly to
the reluctance of non-residents to hold large open positions in any of the relevant
currencies and partly to controls in each country that restrict the ‘internationalisation’ of the domestic currency—that is, controls designed to insulate onshore
interest rates from offshore speculative pressures by preventing residents making
loans to non-residents that are denominated in the domestic currency, and by preventing the emergence of offshore markets in securities denominated in the
domestic currency.
With some exceptions, such as the speculative flurry against the rupiah in mid2004, most of these interventions have involved acquiring foreign exchange
reserves so as to prevent the appreciation of the real exchange rate—that is, to
prevent an increase in the ratio of the price of non-traded goods to the price of
traded goods—and thus raise the profitability of industries producing exports
and import-competing products.
Sterilising balance of payments surpluses to prevent exchange rate appreciation is of course what the Asian central banks did in the boom period that preceded the 1997 financial crisis, and it probably contributed to the occurrence of
the crisis. If, instead of sterilising a capital inflow, the central bank allows the
exchange rate to appreciate, the inflow would be self-correcting, because it would
depress the returns to domestic assets by driving up their domestic currency
prices and, a fortiori, their foreign currency prices. If the exchange rate is allowed
to float, a foreign capital inflow will reduce domestic interest rates. If the inflow
would have been $100 million at the initial level of interest rates, the final inflow
will be less than $100 million because of the fall in domestic interest rates; part of
this reduced amount will finance increased real investment and the rest will be
matched by higher non-resident holding of domestic private securities. If
instead, the exchange rate is held constant and the effects of the capital inflow on
the money supply are sterilised by the sale of short-term bills by the central bank,
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
184
4:18 PM
Page 184
George Fane
the domestic interest rate will not fall and the final inflow will be the initially
planned $100 million, not some lesser amount. Further, the whole of the $100 million will now go into increased non-resident holdings of official short-term bills
and real investment will not rise. Sterilisation therefore switches off the stabilising effects of a capital inflow on interest rates and investment. If the central bank
matches its short-term domestic currency-denominated liabilities with short-term
foreign currency-denominated assets, the reversal of the inflow would not be a
problem, provided that the authorities were willing to run down their foreign
currency-denominated assets in defence of the domestic currency, and provided
that a sudden capital outflow did not generate speculation against the domestic
currency. But since these conditions may not hold, managing the exchange rate
and sterilising the monetary effects of balance of payments surpluses is a dangerous policy.
Offshore Markets in Rupiah, Baht and Ringgit
The growth of offshore currency markets can occur as a result of globalisation,
but is often accelerated by attempts to escape from onshore financial regulations.
Both factors were important causes of the growth of the eurodollar market—the
largest of all offshore currency markets—and both were also important in the
growth of offshore markets in Asian currencies before 1997. Offshore markets in
rupiah, baht and ringgit existed in Singapore and in some other international
financial centres. International banks in these offshore centres were able to accept
deposits in ringgit, baht and rupiah and to engage in spot and swap transactions
between these currencies and the major international currencies, particularly the
dollar. Perhaps because of BNM’s relatively tight domestic financial controls, the
offshore ringgit market in Singapore was particularly large until BNM regulated
it out of existence in September 1998.
Foreign exchange swap contracts, and regulations designed to restrict the use
of such contracts, have been particularly important in offshore currency markets.
Box 1 explains the mechanics of these contracts.
Governments and central banks often view the internationalisation of their
currencies with hostility, since it reduces the effectiveness of their regulation of
the domestic financial system; it also weakens their control over interest and
exchange rates, by allowing speculation in offshore markets to have a direct
impact on domestic interest rates and the spot exchange rate—or on official
reserves, if the central bank intervenes to defend the spot exchange rate.
As an example of how offshore speculation can affect onshore interest rates,
consider an offshore speculator who does not hold rupiah but expects that the
rupiah will weaken sharply against the dollar. If correct, this speculator can make
a profit by borrowing in rupiah, selling the rupiah for dollars in the spot foreign
exchange market, and then buying dollar-denominated securities. The speculator
could achieve the same result by swapping dollars for rupiah, using the rupiah to
buy back dollars in the spot market and then making dollar-denominated loans.
Whether done directly, or indirectly via the swap market, these transactions
would put upward pressure on onshore rupiah interest rates and downward
pressure on the value of the rupiah. To resist these pressures without restricting
access to the spot market in foreign exchange, the Indonesian authorities would
have to make it illegal for residents to lend directly to non-residents in rupiah and
BIESAug05
29/6/05
4:18 PM
Page 185
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
185
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
BOX 1 THE MECHANICS OF FOREIGN EXCHANGE SWAPS
A foreign exchange swap has two parts. In the first part, the two parties to the contract exchange amounts of two currencies that have the same value in the spot market; in the second part, the initial exchange is reversed at a rate that reflects the
originally expected change in the spot exchange rate. As an illustration, consider a
swap between rupiah and dollars, on 1 January when the exchange rate in the spot
market is Rp 8,000/$. In the first part, the two contracting parties exchange amounts
of rupiah and dollars that have the same value in the spot market, for example Rp 8
billion and $1 million. In the second part, which might occur three months later, on
1 April, the initial swap is reversed, but at an exchange rate that reflects the difference between rupiah and dollar interest rates. If the interest rate for borrowing and
lending in rupiah is 12% per year, and therefore roughly 3% for three months, and
the interest rate for borrowing and lending in dollars is 4% per year, and therefore
roughly 1% for three months, the exchange rate for the second part of the transaction, the reversal of the original swap, will be about Rp 8,160/$, that is the initial
exchange rate scaled up by the 2% difference between the three-month interest rates
on rupiah and dollars. ‘Roughly’ and ‘about’ have been used because this numerical example uses simple interest and ignores the minor complications of compound
interest. The party that handed over Rp 8 billion in exchange for $1 million on 1 January will be returned about Rp 8.16 billion in exchange for $1 million on 1 April.
Restrictions on the ability of onshore banks to enter into swaps with nonresidents in which the onshore bank initially provides domestic currency in
exchange for foreign currency are an essential part of an exchange control system
that is designed to prevent the internationalisation of the domestic currency. The
reason is that such swaps effectively involve the onshore bank making a domestic
currency-denominated loan to the non-resident, matched by a foreign currencydenominated loan from the non-resident to the domestic bank.
they would also have to restrict indirect rupiah lending via the swap market. As
explained below, all three central banks have responded to the Asian crisis by
imposing and tightening such restrictions.
Restrictions on the Internationalisation of the Rupiah, Baht and Ringgit
Soon after the outbreak of the Asian crisis, BI issued a regulation to restrict indirect lending by onshore banks to non-residents via the swap market (Bank Indonesia 1998: 65). It further tightened its restrictions on the internationalisation of
the rupiah following the flurry of speculation that saw the dollar value of the
currency fall by 8% between April and June 2004.7 Then, in September 2004, BI
issued a new prudential regulation on the net open position (NOP) in foreign
exchange of the commercial banks—that is, the difference between the values of
7 The
rupiah weakened from Rp 8,661/$ in April 2004 to Rp 9,415/$ in June 2004 (CEIC
Asia Database).
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
186
4:18 PM
Page 186
George Fane
each bank’s foreign currency assets and liabilities, relative to their capital—that
has had the effect of further restricting their access to the swap market. Previously, each bank’s overall NOP had to be less than 20% of its capital, and this
requirement was monitored at the end of each day. Under the new regulations,
both the on-balance sheet NOP and the overall NOP, that is, the sum of the onbalance sheet NOP and the off-balance sheet NOP, must be less than 20% of capital, and this condition must be met at midday, as well as at the end of the day.
The new regulation has substantially hindered banks’ ability to trade in the
swap market. The reason follows from the fact that, as explained in box 1, a foreign exchange swap has two parts: in the first, currencies are swapped, in the second the original swap is reversed. Because of this reversal, the swap does not
change either party’s overall exposure to foreign exchange risk. An Indonesian
bank that swaps rupiah for dollars in the first part of the transaction incurs an
obligation to return dollars for rupiah in the second part that exactly offsets the
net open position that would be produced by the first part of the transaction, if it
were undertaken in isolation. A bank’s overall NOP is therefore unaffected by
swap market transactions, and these transactions were therefore not restricted by
Indonesia’s pre-September 2004 regulations on each bank’s overall NOP. Under
the new regulations, the initial exchange of currencies is recorded on-balance
sheet, but the offsetting commitment to reverse the swap is off-balance sheet. The
new regulations therefore prevent a swap market transaction that would cause
the bank’s net on-balance sheet open position to exceed 20% of its equity.
Policies to prevent the internationalisation of the baht have been part of the
BOT’s response to the Asian crisis. In January 1998, it imposed tight limits on
baht-denominated credit facilities provided by Thai financial institutions to nonresidents unless there was an underlying trade or investment activity in Thailand
(Bank of Thailand 2000), and these restrictions remain in place.
Even before the outbreak of the crisis, direct lending by Malaysian residents
to non-residents in ringgit had been prohibited by BNM’s exchange controls,
and in August 1997 BNM effectively banned indirect lending by setting very low
limits on the amounts of ringgit that onshore banks could offer to swap with
non-residents, unless there was an underlying real transaction, such as trade or
foreign direct investment. Then, as part of the exchange controls introduced by
Malaysia in September 1998, the offshore market in ringgit deposits was closed.
This was achieved by allowing holders of offshore ringgit deposits a grace
period of one month in which to repatriate their deposits to Malaysia, after
which it became illegal for onshore banks to accept inward transfers of ringgit
from offshore banks.
Costs and Benefits of Restricting
Internationalisation of the Domestic Currency
The advantage of allowing the domestic currency to be ‘internationalised’, as
Australia did when it abolished all exchange controls in 1983, is that this adds to
the liquidity of the domestic money market and of the forward and swap markets
in foreign exchange. The smaller the domestic financial system, the more important are these advantages. Allowing international banks to engage freely in the
swap and forward markets gives these markets, which are used by traders and
investors, as well as by speculators, much greater depth than they would have if
BIESAug05
29/6/05
4:18 PM
Page 187
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
187
restricted purely to onshore banks. Access to offshore markets in local currency
adds to the liquidity of the onshore banks in the onshore money market. If these
banks have shortages or surpluses of liquidity in domestic currency, they can borrow from, or lend to, offshore banks.
The disadvantage of allowing the domestic currency to be internationalised is,
of course, that it means that offshore speculative pressures are directly transmitted
to onshore interest rates and the onshore foreign exchange market. But there are
other, more effective, ways to avoid the costs of destabilising speculation, without
forgoing the benefits of internationalisation of the domestic currency. These
include giving the central bank independence to pursue a credible target, such as
low inflation, or slow monetary growth; encouraging the entry of international
banks; improving bankruptcy laws (since the financial system cannot work efficiently if sanctions against defaulters are ineffective); and raising the capital adequacy ratios of banks and other financial institutions. Since it would be hard to
guarantee that even these policies would be completely effective, and since the
costs of the financial crisis of 1997–98 proved to be very high, it is not surprising
that all three countries maintain tight restrictions on the internationalisation of
their currency. While this safety first approach can be defended, the three governments can be criticised for not also moving much more vigorously to implement
the first best policies, listed above, for reducing financial sector vulnerability.
TECHNICAL ASPECTS OF MONETARY POLICY
Monetary Policy Techniques: Indonesia
BI uses two instruments for conducting open market operations, FASBI and SBI.
FASBI (Fasilitas Simpanan BI, BI Deposit Facility) is a term deposit facility. At
present all FASBI deposits are accepted for a term of seven days. SBI are certificates of deposit that are currently issued for maturities of one month and three
months.8 By accepting all deposits offered at the FASBI rate and by adjusting the
outstanding volumes of one-month and three-month SBIs, BI can control shortterm interest rates. Neither FASBI nor SBI is part of base money, so when banks
move their funds from vault cash or excess reserves to either of these instruments,
NDA and base money are both reduced by the corresponding amount.
FASBI grew out of BI’s response to the recent Indonesian banking crisis (Kenward forthcoming). Beginning in September 1997, there was a massive drain on
deposits in the troubled private banks as investors moved funds to the state
banks. Even though the state banks ended up making larger losses, relative to
their share of deposits, than the private banks, depositors correctly perceived that
they were backed by implicit government guarantees. This transfer of deposits in
late 1997 and early 1998 meant that the troubled private banks were experiencing
an acute liquidity crisis at the same time that most state banks had excess liquidity. As a result, the interest rates paid by the strongest and weakest Indonesian
banks on interbank loans regularly differed by more than 100 percentage points:
while the strongest banks could borrow at 40–50%, the weakest had to pay 150%
or more (Bank Indonesia 1999: 62).
8 SBI
with six months to maturity were discontinued in 1999.
BIESAug05
29/6/05
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
188
4:18 PM
Page 188
George Fane
BI responded to the switching of deposits from weak private banks to state
banks by introducing the deposit facility that later became known as FASBI. This
facility offered interest rates that were only slightly below the SBI rate in order to
attract deposits from the strong banks to which depositors fled when they feared
that weaker banks would fail. BI then lent these funds back to the weak banks in
the form of last-resort loans. The enormous losses that resulted from BI’s lastresort lending during the crisis (Frécaut 2004) show that it cannot be justified in
terms of the Bagehot-type recommendation that last-resort loans should be given
freely against good collateral (Bagehot 1920: 164).
Since FASBI deposits are issued for shorter periods than SBI, but are also promises by BI to pay fixed rupiah amounts, they are essentially the same as shortdated SBI. However, whereas SBI are issued at monthly auctions, the FASBI
facility is permanently open and banks can deposit as much or as little as they
wish at the rate set by BI, which at the time of writing is 7%. Because the banks
are not rationed at the SBI auctions, or in deciding how much FASBI to hold, the
two rates are never far apart. The one-month SBI rate is generally about 20 to 50
basis points (0.20 to 0.50 percentage points per year) above the FASBI rate, in
compensation for the greater liquidity of FASBI, but the exact difference depends
on expectations about changes in short-term interest rates.
The regulations that introduced FASBI provided for the possibility of BI offering to accept deposits for terms of up to 14 days. In the event, BI has never
accepted FASBI deposits for terms of more than seven days. It has usually offered
seven-day deposits, and initially it also offered one-day deposits, with rates that
varied according to whether the deposits were made in the morning or afternoon
trading sessions. Before June 2004, the overnight FASBI rate set a floor on the
overnight rate in the interbank money market, since banks would never lend to
each other at a lower rate than that offered by BI. However, in June 2004, BI began
to ration the amount of overnight FASBI that it would accept. The reason seems
to have been its reluctance to pay interest on deposits whose maturities are so
short that they do little to reduce the liquidity of the banking system. In January
2005, BI took this reasoning a step further and stopped accepting overnight FASBI
altogether. The situation at the time of writing was that only seven-day FASBI
were available, and there was no rationing of banks at the 7% rate set by BI.
If there were a deep secondary market in SBI, BI could trade in it to set oneweek interest rates. In practice this market is thin, and BI therefore sets this interest rate directly using FASBI, which offers some extra flexibility that the SBI
system does not possess. Of course the fact that BI operates in this way exacerbates the thinness of the SBI secondary market.
Monetary Policy Techniques: Thailand
The BOT’s primary operating instrument is the 14-day repurchase, or ‘repo’, rate.
The Monetary Policy Committee of the BOT meets about every six weeks to
announce the Bank’s ‘policy rate’, which is its target for the 14-day repo rate.
These announcements generally report the latest data on core inflation, and discuss expected economic developments in the coming year. This background
information is then used to justify the MPC’s choice of policy rate.
To implement the MPC’s decision, the BOT operates in two separate but
closely connected repo markets, the bilateral market and the BOT-operated mar-
BIESAug05
29/6/05
4:18 PM
Page 189
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
Monetary and Exchange Rate Policies in Indonesia, Malaysia and Thailand
189
ket. Trading in the bilateral market is usually conducted once or twice per fortnight. This trading involves the sale by the BOT, under repurchase agreements, of
government securities to nine authorised dealers. The BOT indicates the amount
of liquidity that it intends to absorb and invites tenders from these dealers at various maturities, ranging from one day to one month. Recently, about half of the
volume traded has been for one day and the next most important maturity is 14
days. Some trading takes place at seven days, but only very little is traded for one
month. The BOT does not make a commitment on the total volume to be tendered. Rather, it adjusts this in the light of the bids to ensure that the average
accepted rates are very close to the policy rate. In the case of the 14-day tenders,
all bids must be at the policy rate, but bidders do not necessarily receive the full
amount for which they bid. The BOT decides how much to accept and apportions
the total among the dealers in proportion to their bids.
The BOT-operated repo market is open for one hour on each trading day.
Between 40 and 50 institutions are eligible to bid in this market. These eligible
institutions include large state-owned enterprises as well as banks and other
financial institutions. Buy and sell bids are submitted to the BOT, which matches
them and charges a small commission. As well as operating this market, the BOT
trades in it on its own account, using it to absorb or inject whatever liquidity is
needed to keep the 14-day rate close to the policy rate. The authorised dealers
use the BOT-operated market to adjust the positions taken up in the bilateral
market.
At the end of the day, banks with a shortage of liquidity can borrow from the
BOT at the policy rate plus 1.5%, using government securities as collateral. Those
with surplus liquidity can only leave it in their current accounts at the BOT. Since
these accounts do not bear interest, banks try to operate on a very small margin
of excess liquidity, and the bulk of the funds in their current accounts is there to
satisfy statutory reserve requirements. The BOT does have provisions for allowing banks with current account deposits in excess of their statutory requirements
to obtain a ‘credit’ against their future statutory requirements; that is, if they held
more than the required amount of reserves in one month, they can hold less than
the required amount in the next. Currently, the statutory reserve requirement is
1% of customers’ deposits. There is also a requirement that banks keep liquid
assets of at least 6% of customers’ deposits. Liquid assets are defined to include
current accounts at the BOT (although the required reserves are not really liquid),
vault cash and government securities. At the time of writing, banks have large
holdings of government securities and the demand for bank loans is low. As a
result, the liquid assets requirement is not binding and banks hold well in excess
of the 6% minimum.
Since lending to a central bank in its own currency is essentially risk-free, the
BOT does not really need to provide collateral for its borrowings from the financial system. Its reason for borrowing via repos, rather than employing a ‘pure
borrowing’ facility like BI’s FASBI, is that the collateral that it provides to the
institutions that lend to it can be used by these lenders as collateral for their own
borrowing, if the need arises. This deepens the market in government paper and
gives the lending institutions more flexibility than they would have if their lending was in the form of a non-transferable term deposit at the BOT. This has the
advantage for the BOT that financial institutions are willing to accept slightly
BIESAug05
29/6/05
4:18 PM
Downloaded by [Universitas Maritim Raja Ali Haji] at 19:47 19 January 2016
190
Page 190
George Fane
lower interest rates than the BOT would have to pay if it simply offered term
deposit facilities.
Although the bulk of the BOT’s open market operations are done in the repo
market, it does sometimes purchase government securities outright. Since one of
its long-term goals is to build up its portfolio of government securities, it does not
generally engage in outright sales of them, and since most of its monetary operations are intended to absorb liquidity rather than inject it, its outright purchases
are infrequent and generally small. It can also use the swap market to affect
domestic monetary conditions. For example, it can absorb domestic liquidity by
swapping the foreign currency-denominated assets that it holds in international
financial centres for baht.
Monetary Policy Techniques: Malaysia
BNM currently faces the problem of absorbing the large capital inflows that
Malaysia is experiencing as a result of the widespread expectation that its temporarily fixed exchange rate may soon be revalued upwards relative to the dollar, and almost certainly will not be devalued in the near future. The special
features of BNM’s monetary operations that distinguish them from those of BI
and the BOT are due to the fact that it is constrained in the ways that it can
absorb liquidity. BNM’s own holdings of Malaysian Government Treasury Bills
(MGTBs) or other Malaysian government securities are too small to absorb more
than a limited amount of the capital inflows of the recent past.9 Most of the
Malaysian government’s outstanding securities are held by ‘captive institutions’, such as insurance companies and the Employee Provident Fund (EPF),
which are legally required to invest in government securities. At the same time,
the Central Bank of Malaysia Act of 1958 fixes the maximum amount of BNM
paper that can be issued relative to its capital, and this limit is now binding. As
a result of this legal constraint, the Rgt 17 billion of Bank Negara paper now outstanding can be rolled over, but can only be increased in proportion to increases
in BNM’s capital.
As a result of the constraints described above, BNM’s monetary operations
mainly involve direct borrowing from the banks and other financial institutions
in the form of deposits. Each morning, BNM announces a daily tender at which
the banks bid for the right to place short-term deposits at BNM at rates that are
usually very close to the ‘overnight policy rate’ (OP