In 2018, Indonesia initiated monetary cooperation with two ASEAN countries marked by the Local Currency Settlement framework as a foreign currency exchange system. The two ASEAN countries are Malaysia and Thailand. Now, the implementation of this monetary policy continues to be pushed and has spread to Japan and China.
Local Currency Settlement (LCS) is the settlement of bilateral transactions carried out by two countries using the local currency prevailing in each country. This policy aims to reduce dependence on the US dollar currency for bilateral trade transaction settlement and maintain the stability of the local currency value.
The implementation of LCS is established through the cooperation of the central bank in each country. Then, the central bank appointed several banks in their respective countries to be an Appointed Cross Currency Dealers (ACCD).
The banks designated as ACCD are banks deemed to have the ability to facilitate transactions in foreign currencies following the agreed LCS cooperation framework. There are three basic judgments in the appointment of ACCD banks.
First, the bank was considered to have a good level of business resilience and health. Second, they are experienced in facilitating trade/investment transactions and can provide various financial services. Third, having good cooperative relationships with banks in partner countries.
As the central bank in Indonesia, Bank Indonesia initiated this LCS collaboration with Bank Negara Malaysia (BNM) and the Bank of Thailand (BOT). Then, LCS cooperation expanded in 2020 through an MoU signed between the Ministry of Finance of Japan and Bank Indonesia. Most recently, Bank Indonesia (BI) and the People’s Bank of China (PBC) officially started the LCS cooperation implementation on September 6, 2021.
There are four types of transactions facilitated by LCS, namely:
- Trade in goods and services between Indonesia and partner countries (receipt of import/export payments).
- Primary income transactions, such as receipt and payment of labor compensation transactions, as well as investment income (direct investment, portfolio investment, and/or other investments).
- Secondary income transactions, such as remittances that include receipts and payments from the government sector or other sectors. except for grants, prizes, donations, and/or the like.
- There is a direct investment between Indonesian LCS customers and LCS customers from partner countries, with a minimum limit. 10% ownership of the company.
Innovative Steps in Strengthening the Positively Welcomed Econmy
Before the LCS cooperation framework formed, bilateral trade transactions always used US dollars in the payment system. For example, if an Indonesian entrepreneur wants to trade with a Thai entrepreneur, they must convert Rupiah into dollars first and then exchange it for Bath currency, and vice versa.
That situation makes trade and business activities between the two countries inefficient because it takes more time to convert their money into US dollars. In addition, the currency exchange practice can also impact the value of the dollar to strengthen, which can indirectly make the local currency depressed.
Therefore, many parties gave a positive response when Bank Indonesia initiated the LCS cooperation framework. It is because the LCS cooperation framework considered providing many benefits for business players, such as:
- Without cross-rate with US dollars, transaction conversion costs become more efficient,
- Availability of alternative export financing/direct investment in local currency,
- Availability of alternative hedging instruments in local currency, and
- Diversification of exposure to currencies used in settlement of transactions.
Doddy Zulverdy, Executive Director and Head of Department of Bank Indonesia, explained that the implementation of LCS with partner countries has shown a positive trend. The application of LCS from Indonesia’s total trade with Malaysia in 2018 only reached 1.4 percent. In 2019, the share rose to 3.6 percent and 4.1 percent in 2020.
The same thing happened with Thailand. In 2018, the implementation of LCS only reached 0.6 percent. Its market share increased to 1.1 percent in 2019 and will rise to 1.3 percent in 2020.
In Japan, this upward trend is also visible. The portion only reached 0.7 percent in the first three months following the signing of the LCS agreement in 2020.It increased by 3.4 percent in the first six months of 2021.
The LCS policy is one of the innovative moves from Bank Indonesia’s many policies to create a better economy. The presence of LCS is also a breath of fresh air for business players because now they can use their respective countries’ currencies in completing bilateral transactions.
Thus, the dependence on the US Dollar currency for bilateral trade transactions settlement is expected to be reduced. In the end, this will help the country maintain the stability of the local currency value.