Attracting dollar without risk<\/p>\n
By C.J. de Koning<\/p>\n
This is the first of two articles on the Indonesian monetary
\ncrisis.<\/p>\n
JAKARTA (JP): Prominent economist Prof. Dr. Soemitro
\nDjojohadikoesoemo called recently for a lowering of rupiah
\ninterest rates because the current rates of over 58 percent are
\nstifling the local economy.<\/p>\n
Former minister of finance Mar'ie Mohammad also recently
\ncalled for a reintroduction of a managed floating exchange rate
\nfor the rupiah against the U.S. dollar.<\/p>\n
Last year's loan package arranged for Indonesia by the IMF
\ncarried as an assumption that the rupiah-U.S. dollar exchange
\nrate would stabilize around the Rp 6,000 level during the course
\nof this year. In the latest agreement between the IMF and the
\nIndonesian government an exchange rate of Rp 10,000 to the dollar
\nis assumed. The rupiah is currently trading at over Rp 15,000 to
\nthe U.S. dollar, an exchange rate which has forced 70 million
\nIndonesians below the poverty line.<\/p>\n
Exchange rates, interest rates, local prices and the local
\neconomy are inextricably linked.<\/p>\n
Many economists base their advice on the theory that if you
\nincrease local currency then interest rates substantially. The
\nsavings ratio will then increase both from domestic and foreign
\nsources, and local consumption, imports and investment levels
\nwill drop because borrowing has become more expensive.<\/p>\n
High interest rates will also cause the rupiah to strengthen
\nagainst the dollar because overseas savings which are converted
\ninto local currency will increase the supply of dollars and
\nthereby strengthen the rupiah. Furthermore, the excess production
\ncapacity created by reduced local demand can be used to increase
\nexports.<\/p>\n
It is clear that the assumed exchange rates of at first Rp
\n6,000 and later Rp 10,000 have not been achieved in practice
\nbecause markets behave differently to the way theory would have
\nus believe.<\/p>\n
To understand why this is so we must first consider what
\nfactors determine the rupiah-dollar exchange rate.<\/p>\n
The exchange rate is determined by trade flows consisting of
\nIndonesian export income and import expense, and by capital flows
\nto and from Indonesia which together determine the supply and
\ndemand for foreign currency in this country.<\/p>\n
Capital outflows are loan and interest (re)payments, outward
\nbound portfolio investment and disinvestment by foreigners both
\nfrom the local stock market, directly owned companies and
\nindividual assets, plus free transfers into a foreign currency.<\/p>\n
Capital inflows are loans from the IMF, World Bank, Asian
\nDevelopment Bank and foreign commercial banks, as well as money
\nfrom international depositors. Foreign investments in the local
\nstock market or in any other local asset base (company or real
\nestate) also bring in foreign currency.<\/p>\n
We may also consider some of the changes in behavior patterns
\nby the various groups who have been operating in Indonesia's
\neconomy since June last year.<\/p>\n
Foreign lenders (i.e. foreign banks) have in general taken a
\nmore cautious view of events in Asia since the Thai economic
\nslide began. This in practice meant less foreign currency credit
\nand therefore a higher net demand for dollars out of existing
\ndebt positions as supply reduce and demand increased.<\/p>\n
If -- as in Indonesia's case -- short term foreign currency
\ndebt dominates the corporate and local bank debt schedule, then a
\nshift by foreign banks from continued lending to reducing
\noutstanding claims led to a heavy demand for U.S. dollars.<\/p>\n
It may be estimated that some US$35 billion to $40 billion in
\ndebt servicing became due between July 1997 and June 1998,
\nagainst which only $10 billion in new loans were granted. These
\nfigures require fine tuning if a better record of capital inflows
\nand outflows is to be maintained.<\/p>\n
On the trade financing front, foreign lenders reduced their
\ncombined exposure on local banks from $13 billion in October last
\nyear to $4 billion on April 30 this year.<\/p>\n
Foreign investors in the Jakarta stock market have also cut
\nback their activities. In June last year the Jakarta stock market
\nhad a value of $100 billion. By the end of June this year the
\nvalue had fallen to $14 billion.<\/p>\n
Foreign investors in companies and to a much smaller degree
\ninvestors in real estate or local currency began to exercise more
\ncaution after political and economic turmoil increased. Foreign
\ndirect investment levels and foreign inflows into the local
\ncurrency decreased as a result.<\/p>\n
Many companies and local banks borrowed money in U.S. dollars
\nand used these funds to finance operations in rupiah. The
\ncompanies estimated the exchange risk for the rupiah-dollar at 5
\npercent per annum and the interest gain at 20 percent to 25
\npercent per annum, leaving a positive risk margin of 15 percent
\nto 20 percent per annum. All this changed when the rupiah was
\nfreely floated, but it should be pointed out that at the time,
\nthe assumptions about exchange rate depreciation were made in
\naccordance with official government policy.<\/p>\n
Many local banks had open currency positions. As the rupiah
\ndepreciated and local interest rates increased, they had to
\nconvert more rupiah to get the same number of dollars. These
\nrising costs could no longer be fully transferred to the
\nborrowers, leading to substantial loan loss provisions and in
\nsome cases to liquidity losses, bank closure or transfer to
\nIndonesian Bank Restructuring Agency supervision.<\/p>\n
The final group of players are local people. The closure of 16
\nbanks on Nov. 1, 1997, increased uncertainty and damaged
\nconfidence, especially since initially there were no arrangements
\nmade to compensate these banks' depositors. This uncertainty led
\nto a flight into U.S. dollars, some of which went overseas. Again
\nit is very difficult to guess how much capital left the country
\nor was changed into U.S. dollars, but it was not an insignificant
\namount.<\/p>\n
The clear conclusion from the above is that the supply of
\nforeign currency fell substantially at the same time as demand
\nincreased dramatically.<\/p>\n
The writer is Country Manager Indonesia for ABN AMBRO Bank.
\nThis article was written in a personal capacity.<\/p>",
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