Grainne Mccarthy, Jakarta – Speculation that Indonesia is planning to implement capital controls roiled financial markets despite denials from the country's president and central-bank officials that such a move is in the cards.

Indonesia and the International Monetary Fund – which is leading a bailout package for the country – have repeatedly stated their opposition to controls on capital flows. Since taking office in May, President B.J. Habibie has said there is no possibility of limiting currency flows. On Tuesday, he reiterated that view in an interview with The Asian Wall Street Journal, saying: "No, that's for sure, as long as I'm here, no." Bank Indonesia Governor Sjahril Sabirin later echoed those sentiments in a brief interview.

Still, foreign traders said even the possibility of controls has sent many moving to clear their Indonesian stock portfolios. The Jakarta Stock Exchange composite index sank 8.9% Tuesday to a new five-year low and continued to slip Wednesday.

Rupiah climbs

The Indonesian currency strengthened to 11,150 rupiah to the dollar Tuesday on the rumors, from 11,450 rupiah on Monday, and was trading at 11,100 rupiah in late Asia trading Wednesday. Investors and traders said the rupiah surged because players believe that if Indonesia does impose controls, the government would likely peg the rupiah to the dollar at a stronger rate than now.

People close to the government say that while the issue has been discussed since Malaysia imposed its own controls on Sept. 1, a consensus had emerged not to follow suit. James T. Riady, a prominent businessman and special envoy of the president, said capital controls "would be a huge change and you would have to be ready for the consequences. Indonesia is not ready for those consequences." He added that the sprawling country would have difficulty implementing such controls without setting up a huge bureaucracy, which in turn could feed "the corruption that comes with it. If anything, there will be more outflow" of capital.

Instead, he said, the government badly needs to portray a stable political and economic climate to woo back foreign capital and investment. Any talk of controls would upset not only the market, but also the IMF and other lenders. "Support from international institutions has been very good and provided some roadmaps to get us somewhere," he said.

Growing anxiety

Winning international confidence is crucial to recovery, he said. Indonesia faced further uncertainty this week as riots over food prices flared in parts of the country. Students, too, have taken to the streets, some of them demanding Mr. Habibie step down and the military abandon its political role. Talk of capital controls has added to the anxiety. "Just this talk of currency controls has put everything back a week, two weeks," said a senior Indonesian business executive. Despite the government's denials, many analysts stuck to their view that Indonesia is planning some form of controls – albeit nothing as stringent as those adopted in Malaysia. "It's a game of perception. The market strongly believes that you are bound to do it if you keep on denying it," said Harry Danardojo, managing director at Lippo Securities. He said the market's logic is that the government will keep on denying it and then "a few minutes later they do it – bang – without any announcement." Traders remain nervous about the central bank's ongoing search for ways to stabilize the currency. It has said it is considering some form of managed float for the rupiah, under which the currency would trade in a band, rather than freely as is the case now. The IMF has said it might eventually support a return to a band system. The central bank had stressed, though, that this doesn't mean Malaysia-style limits on capital flows.

'Not worth the risk'

That assurance didn't stop panic selling of shares on Tuesday, however. "Foreigners were dumping shares because they were afraid of the same fate they faced with Malaysia," said Ali Naqvi, vice president for Asian equities at Credit Suisse First Boston in Singapore. Malaysia on Sept. 1 announced that money foreigners had invested in Malaysian shares couldn't be taken out of the country for a year. "If the market's already bad and then on top of that this huge risk comes on – whether it's a rumor or not – it's still just not worth the risk," he said.

Bank Indonesia also is concerned about inflows of so-called hot money to take advantage of 70% interest rates on government certificates, fearing the fast-moving funds could suddenly flood out at any sign of uncertainty. But economists warn that any attempt to impose currency controls now would jeopardize sorely needed IMF funding, and deter Indonesian investors from repatriating the vast quantities of capital that left the country earlier this year. "Although there is an argument in favor of managing capital flows, across-the-board controls would be negative for the economy," said Paul Alapat, senior economist at Credit Agricole Indosuez in Singapore. "The danger of capital controls is that they cut both ways. Not only do they deter hot money flows, but they discourage the recycling of flight capital."