Independence of Bank Indonesia as Central Bank

Bank of Indonesia as Monetay Authority M. Khairul Bahri (24007044)

BANK INDONESIA’S INDEPENDENCE: A NATIONAL INNOVATION SYSTEM REVIEW

By

MUHAMAD KHAIRUL BAHRI

INSTITUTE OF TECHNOLOGY BANDUNG 2009


Introduction Aspects of Innovation: Independence Task Bank of Indonesia (BI) as the monetary authority.

In the Old Order period1, President Sukarno ordered the Bank to print more money to finance GANEFO (as an Olympic sports event counter). As a result, the era of the 1960s inflation had skyrocketed to 600% / year.

Meanwhile, during the New Order, the Governor of BI including a ministerial-level officials is a member of the Monetary Council which is responsible to the president. With close relationship between entrepreneurs with the monetary authority made banking ease to manipulate banking supervision and to get BLBI (Bank Indonesia Liquidity Assistance). Whereas the value of assets owned businesses are far below the amount provided BLBI. A result of which no prudent BLBI, the rupiah had fallen sharply and inflation reached 80% 1997-1998.

To reduce above inflation necessary expenses of banking recapitulation worth hundreds of billions and even trillions (includes cost of recapitulation and interest payments). This fee is taken from the IMF granted debt. To curb inflation and restore public confidence, the government disbursed BLBI (trillions of rupiah of debt sourced from foreign, the debt from the IMF), but BLBI who returned less than 20% of his BLBI value. While our debt load increased to 80% of GDP (1998 - source: World Bank).

On the other hand, the fall of Indonesia's monetary crisis has interrupted many economists predictions (including Rostow), which predicts Indonesia is a potential of "A New Asian Tiger". Even Rostow predicted Indonesia will emerge as the new industrial countries in 1998. As a consequence of the signing of the LoI (Letter of Intent with the IMF) Indonesia are required to make the monetary authority (Central Bank) as an independent entity, so it can run without the intervention of the monetary activities of any party.

To support this progress a team was formed by some experts who formulated the legal texts regarding the independence of the BI which later became the basis for the formation Law. 23 Year in 1999 as a legal basis the independence of Bank Indonesia as the monetary authority.

Issues Background

History also shows non-independence of BI in performing his duties have been difficult for Indonesia to maintain a lasting macroeconomic stability. Old Order period marked a very high inflation rate due to the habit of "printing money again, if we need". Whereas during the New Order Period2, Bank Indonesia supervision task does not run well marked that no prudent lending. The independence of BI (in performing his duties) are very important in the light of the aspects of

a) the amount of capital owned by Bank Indonesia (Act 23 of 1999: a minimum capital of BI 2 trillion);

b) the monetary responsibilities of a very strategic, including the supervision of banks in Indonesia

c) contain the lives of many people, a stable exchange rate, interest rates will affect the welfare of all sections of society.

The purpose of BI of the first establishment of Independence, the real independence, it is not the goal, but the road to reach the goal of central bank independence in performing his duties as a monetary authority. Analogues, independence was no different than like a diploma degree. While the goal of graduation degree is to create graduates who are qualified, not merely to obtain a graduate diploma.

1 Indonesia within 1945 - 1966 2 Indonesia within 1967 – 1997 and reformation era started in 1998 while Mr. Habibie was assigned to be President


So graduate diploma is very important, but it will not be automatically qualified graduates. Much effort should be made to produce quality graduates.

Likewise with independence. With the existence of an independent status does not necessarily mean that the central bank would be able to achieve its objectives. The central bank also does not mean it will be transparent and consistent with itself. Absolutely needed a strategy and a planned program to build the independence of central bank as we expect.

Independence means that the responsibility is clear (clear accountability). This means that Bank Indonesia as the central bank was given a clear responsibility to control the state of monetary economics. Bank Indonesia was given the responsibility to determine the rate of inflation, interest rates and exchange rates to formulate policies to achieve these targets (instrument independent). BI cases during the old order and the new order to show that monetary policy should not be intervened by other policies that macroeconomic variables (such as exchange rates, inflation) can be controlled. The term that is closely related to monetary policy are: monetary policy is not subordinate the other policies. [Monetary policy should not be sacrificed for the benefit or other policies].

We can see from the fall of President Sukarno and Suharto, that the political turmoil that had brought down two presidents started with the collapse of the Indonesian economy is marked by very high inflation.

Relevance Issues

BI independence of monetary authorities is very important as balanced with adequate transparency and accountability. Since the independence of BI have the discretion in determining the use of the budget (a minimum capital of BI according to Law No. 23, 1999: Rp. 2 trillion). Using a very large budget certainly requires accountability mechanisms. The independence that are not balanced with accountability would reduce the level of public trust (including internationally). Low level of trust has implications for the cost of handling a larger inflation (that means also a decrease of foreign exchange). Inflation also has implications for the large decline in economic growth and handling of unemployment. In other words, the independence of BI in a transparent and accountable is important for all classes of society: not only members of House of Representatives who feel the benefits of independence of the BI which is accountable but included among the business community and other communities.

If aspects of independence, transparency and accountability are met, then create a forward looking economic expectations. The point is that people believe that BI is the central bank independent and credible and believe that BI will be able to guarantee a stable exchange rate, interest rates and inflation rates. If inflation expectations in the business world (society) in accordance with the expectations of BI, the cost to bring down inflation to be lower.

The result of the collective / aggregate

Independence of the BI which is characterized by freedom in conducting monetary policy and the appointment of the board of governors by the president and approved by the House of Representatives. But there is also a lack of independence of BI, for example, flow of funds controlled by the case of BI to the House of Representatives and legal assistance for some retired BI officials. Independence of the of BI moved into irresponsible actions.

Since 2004, Bank Indonesia to channel funds to the Indonesian Banking Development Foundation (YPPI), half of these funds are given to officials of the BI-related legal cases and the remainder is given to the House of Representatives. Please note, that the BI is government cash so only with the government affairs of the BI has a debt NOT to House of Representatives. This case was revealed


early in 2008. This shows the weakness of the House oversight over the performance of Bank Indonesia, particularly in the management of the BI budget.

Act mandates (Act No. 3 of 2004) directed the formation of Supervision Agency to review the financial statements of Bank Indonesia. Report the results of studies conducted BI Supervisory Body should not be released to the public (given only to the House of Representatives). This will reduce the transparency aspects and by itself because it is not transparency, responsibility, independence of the BI has become less independent.

Aspect of justice is not fulfilled where the public and economic actors can not know the performance and accountability of Bank Indonesia. Whereas the performance of Bank Indonesia will not only affect the economic life of the community members of House of Representatives but also all people in Indonesia.

Independence features of BI [after initiation]:

a) Appointment of the official central bank governor with the approval of the proposed president and House of Representatives;

b) The Board of Governors of Bank Indonesia can not be dismissed by the president; c) Act ensures BI can resist external intervention;

BI is free to do an operation to support monetary policy and inflation target (instrument independence). For example, the BI does not need to ask permission to the president or the House of Representatives in determining the type and large monetary operations needed to reduce the rate of inflation and maintaining exchange rate fluctuations.

Supervision of the House of Representatives for the performance of Bank Indonesia, aided by the Agency for Supervision of Bank Indonesia who regularly review the consolidated financial statements of the Bank of Indonesia to the House of Representatives. Supervision Agency was responsible for reviewing reports and annual financial report of Bank Indonesia investment. But the task of the Supervisory Board was not included in the study of accountability and performance assessment of Bank Indonesia.

In the system prevailing in Indonesia, the president is elected by the people who determine the inflation target. System of monetary targeting by the president continue to give independent status to the central bank. The freedom given to the central bank is not in determining the monetary targets, but in determining how to achieve these targets and inflation targets are then announced through mass media BI (www.bi.go.id). The experts say this central bank's position referred to as instrument independence.

Central bank independence means that this institution is free to determine how to achieve goals that have been determined, and the decisions it has made very difficult for other institutions within the government to change it. But the freedom to determine how to achieve the target does not mean that central banks determine their own goals.

This independence of BI tasks, so as not out of the corridor, must satisfy the principle of accountability and transparency. With the fulfillment of the principles of transparency and accountability, the independence of the central bank will remain on the path independence of the BI task as monetary authorities within the framework of the Unitary Republic of Indonesia is responsible for the independence of the BI.


Analysis: A continuation of the monetary crisis in 1997 was the signing of the LoI (Letter of Intent) that one of them requires the independence of the Central Bank. Preparation is the independence of BI team of experts from the IMF and later, president Habibie asking for help Helmut Schlesinger, the former Governor of the Bundesbank (Central Bank of Germany), to assist the team of experts above.

It is clearly seen that the independence of the BI system initiated by the authorities (government) and system science (economic think thank / economic experts). The system includes the authority of his government and The House of Representatives and the science system includes an expert team of the IMF.

Resistance came from the society (community and business world) who want transparency and accountability in the use of the BI budget. This resistance appeared due to handling BLBI, BI flow of funds to members of House of Representatives (and officials BI), a late note. Resistance also came from the House of Representatives over BI funds flow involving a number of members of House of Representatives.

Resistance also came from among the Supervisory Board who wanted greater authority so as to control the use of budgets as well as assessing the performance of BI.

Conclusion ◊ Independence has shown benefit in improving macroeconomic stability, including increased foreign reserves, control of inflation, interest rates and the exchange rate. BI task has not been matched by transparency and accountability aspects of the balance.

◊ Independence BI funds flow case to the House include assistance for BI officials involved in the case law and legislation giving money to a number of members of House of Representatives. This has been happening since 2004, but was only revealed in 2008. Shows the weakness of monitoring mechanisms on the Bank Indonesia.

It is not yet balanced by the aspect of transparency and accountability, the independence of the BI task was "too far".

◊ In a sense, the BI has made use of the budget beyond the originally mandated independence.

Recommendations: Involving Market System:

The performance of the monetary authority affects the wider society. Therefore, the involvement of market elements in the supervision / independence of the BI formation of an accountable (and transparent) become inevitable. Supervision Agency with membership enriches the business world (including MNC = Multi National Corporations) and to meet the academic aspects of justice. This means that the business community (and not the business) can monitor the performance of BI, which is good-bad performance of the BI may affect their welfare.

The rupiah rate (the main task BI) is closely related to the forex market. Foreign exchange market (forex) can be defined as a form of financial markets in which foreign currencies are traded or exchanged with one another. Market participants who are actively involved in the forex markets include multinational companies which act as the exporter / importer (MNC), fund managers, brokers, foreign exchange dealers of foreign banks and central banks. Elements we expect multinational firms can provide their feedback about the implementation of monetary policy that can give security to the MNC, and they did not do a capital outflow.


Elements in the business world Supervision Agency can provide clues to BI how monetary policy should be able to support real sector growth in Indonesia, which last five years the difficulty in increasing its role in Indonesia's economic growth.

To oversee the independence of BI in carrying out its duties, it is deemed necessary to expand the membership and authority of the Supervisory Board. Assess the performance of their duties coupled with the Board of Governors, propose candidates for BI governor's council to the president. Expanding the authority of the Supervisory Board is important because monetary authorities need to be held accountable not only the use of budgets, but also the assessment aspect of economic performance (inflation target, interest rates and exchange rates). Aspects of performance appraisal can be used to measure how much the efficiency of monetary operations (which also use the budget) in achieving macroeconomic targets to be achieved BI.

Expanding the authority of the Supervisory Board is very important in the light of fluctuations in macroeconomic variables that change relatively quickly. Changes in currency exchange rates and interest rates took place on a daily basis (business cycle). So with the establishment of a central bank regulatory agency is relatively small, can be increased mobility of supervision.

There are several aspects that are met by extending the authority and membership of the Supervisory Board of Bank Indonesia:

a. Aspects of justice, in which people participate assess the performance accountability and transparency-BI;

b. Synergy incentives, where the professional and financial incentives converge. With the expansion of the authority of the Supervisory Board of BI, the incentive to assess the performance, accountability and transparency BI (independent) together with financial incentives granted to the Supervisory Board;

c. From single to multi-purpose, expanding the authority of the Supervisory Board will balance the aspects of the independence of the BI with the aspect of transparency and accountability. With transparency and accountability, the Independence of BI must be united with transparency and accountability.

d. The development of knowledge, about how to improve the performance of Bank Indonesia, which also means maintaining the economic stability of Indonesia towards sustainable economic growth.

In proposing the Governor of BI, occasional limited options provided by the government as candidate of governor BI. Increasing the membership element Supervision Agency BI enriched with elements of society (academia, business circles) of this entity can be used as a place of "seeding" the candidate of the Board of Governors of BI.

Government System

Science System

Government System

Science System

Market System

Documents

Independence of Bank Indonesia as Central Bank