JAKARTA, JUNE 28, Reuter - Indonesia's bank dealing rooms are awash with rumours the central bank will soon give up its control of the foreign exchange market, and some bankers fear that the rupiah may then take a nosedive.

At the moment, Jakarta runs what a senior finance official called a "free dirty float". Bank Indonesia sets a six rupiah range against the dollar every day. Banks can trade outside the range if they wish, but in a one-way market where everyone looks for dollars and the central bank is the main dollar supplier, its rates usually win the day.

The rupiah has been firmly under Bank Indonesia's wing since it removed a dollar peg and devalued 31 pct overnight in 1986. Since then the rupiah has been sinking against the dollar by five to six pct a year.

Indonesia is determined to let non-oil exports lead the way to economic growth and a controlled depreciation is critical to Jakarta's plans.

Bankers said a free market rupiah would remove Jakarta's policy control but would be in line with deregulation of capital and money markets, putting Indonesia's financial sector on the road to sophistication.

Until recently devaluation fears were a major hurdle both to investors and currency traders. Then last October Bank Indonesia extended its currency swaps from six months to three years. Investors began to think if the central bank was prepared to lock itself into an exchange contract for three years, it must be truly dedicated to avoiding a massive devaluation.

But for currency dealers the fears remain.

Most bankers support a market-driven rupiah rate but they are apprehensive about the logistics of stripping Bank Indonesia of its control of the market.

One dealer said the rupiah would drop by 20 pct overnight if the floor were taken from under it.

"It all boils down to confidence in the rupiah, and there is none. Already I have clients asking about shifting money to Singapore," the dealer said, adding that the rupiah would quickly settle at a new, lower equilibrium.

The central bank denies immediate plans to end daily currency control, although it does say it wants a more active market. The rupiah rate, nominally set against an unspecified basket of currencies, has begun to track the dollar's movements more accurately than ever before.

"It used to be when the dollar rose the rupiah fell, and when the the dollar fell, the rupiah fell anyway," a foreign bank dealer said. When the the dollar hiccoughed nearly two weeks ago and drifted lower against the yen, the rupiah saw a slow rise.

But bankers feel that is all the preparation they are likely to get for any central bank hands-off. "It can't possibly be evolutionary. It would have to happen in one fell swoop," said one banker. Indonesia allows money to flow in and out of the country unrestricted, but it does have other regulations which keep a lid on the market.

Since May, all banks in Indonesia have to finish each day with under 25 pct of capital exposed to foreign currencies.

Foreign banks, key players in the foreign exchange market, often find themselves at the end of the day buying rupiah that they will reconvert to dollars the next day.

They say Bank Indonesia's sure supply of dollars oils the tiny foreign exchange market, and fear that if supply dried up they would be left holding unsaleable rupiah. "There's no depth. Bank Indonesia sells dollars and everyone else buys. People only buy rupiah if they have to, and that doesn't make for a liquid market," a foreign banker said.

To encourage people to buy rupiah, making for a real two-way market, dealers say interest rates will have to shoot up, flying in the face of government determination to bring them down. More expensive borrowing would jeopardise domestic investment. Those sceptical about the currency market rumours say that is another good reason to disbelieve the talk.

"Even if the market does go to a freer float, it doesn't mean we won't see the central bank again. If things are moving in the wrong direction at the wrong speed, they will come back in. The Fed (the U.S. Federal Reserve) does it, the Bank of Japan does it. Why not Bank Indonesia?" a dealer said.