Fine-Tuning an Open Capital Account in a Developing Country: The Indonesian Experience

Indonesia has operated a liberal capital account permitting relatively free flow of international non-FDI flows since the early 1970s. In this paper, we review the Indonesian experience and the effectiveness of capital restrictions during 1990-2010 using a SVAR model of the Indonesian economy. Because of severe data problems in the pre-1997 period and because the Indonesian monetary policy and broader macroeconomic regime underwent fundamental changes since the 1997 crisis, we also estimated a model separately for the 2000-2010 period. Both sets of results suggest that inflow and outflow restrictions have been effective for FDI but largely ineffective for portfolio capital. However, the 2000-2010 model results indicate not only that restrictions on inflows have a short-term impact on restricting portfolio flows, but also suggest that controls on inward portfolio investments have some ability to shift funds from short-term to longer-term markets, though the impact is short-lived.