Defending the rupiah<\/p>\n
The joint concerted efforts of Bank Indonesia and the
\ngovernment to defend the rupiah exchange rate, which fell to a
\nthree-year low of nearly Rp 9,800 against the U.S. dollar on
\nTuesday, should have come as early as March, after the fuel price
\nincrease set off stronger inflationary pressure and the U.S.
\nFederal Reserve further tightened its monetary policy.<\/p>\n
Bank Indonesia's open-market ammunition alone would not have
\nbeen powerful enough to address the combined impact of the
\nstronger inflationary pressure and the steady rise in the U.S.
\nFed funds rate to as high as 2.75 percent at present.<\/p>\n
Hence, the government directive that such state companies as
\noil and gas company Pertamina -- which need large sums of foreign
\nexchange for their daily operations -- must coordinate with the
\ncentral bank to buy dollars, is a rational move to prevent a
\nshock in the market.<\/p>\n
Such coordination is essential because the foreign exchange
\nmarket volume is quite small, ranging from only $250 million to
\n$400 million a day. Since Pertamina needs some $80 million a day
\nfor financing its oil imports, its purchase alone could cause
\nthe dollar rate to rise steeply on the spot market.<\/p>\n
Hence, allowing the oil monopoly to buy dollars directly from
\nBank Indonesia, instead of going to the spot market, could help
\nprevent a market shock.<\/p>\n
The latest developments in economic fundamentals and the level
\nof the country's foreign reserves, which remained at a
\ncomfortable level (equivalent to six months' imports), did by no
\nmeans warrant the more than 5 percent depreciation of the rupiah
\nfrom its January level.<\/p>\n
Speculative attacks have played a part in the downfall, and
\nthe central bank should be blamed for allowing the speculation to
\nrun almost freely for a few days, before moving firmly to deploy
\nits open-market weapon to eradicate negative sentiments against
\nthe rupiah.<\/p>\n
The central bank should have been fully aware that the
\ncondition is highly vulnerable to currency speculation, given the
\nlarge sum of excess liquidity at banks that can instantly be used
\nto attack the rupiah and the recent redemption of around Rp 30
\ntrillion in mutual funds, due to deep concern over the declining
\nreturns on government bonds.<\/p>\n
Bank Indonesia succeeded in curbing the rupiah's decline in
\nmid-2004, after it acted firmly and quickly to soak up excess
\nliquidity by introducing a new instrument -- a seven-day
\nintervention rate to supplement the overnight facility --
\nincreasing the compulsory bank reserve requirements and reducing
\nthe net open position of assets and liabilities in foreign
\nexchange to 20 percent.<\/p>\n
The central bank should be more than a reactive institution.
\nIt must anticipate any speculative attacks on the rupiah --
\nhowever light they might be. Allowing the rupiah to depreciate
\nbeyond its ordinary range was surely a positive signal for
\ncurrency speculators to step up their attacks.<\/p>\n
Bank Indonesia said it would resume the weekly auction of its
\npromissory notes (SBI) to soak up liquidity from the banks, but
\nthat apparently is not enough because the U.S. Fed has signaled a
\nfurther increase in its Fed funds rate.<\/p>\n
A higher interest rate differential between dollar and rupiah
\ndeposits would surely prompt the shifting of more financial
\nassets from rupiah to dollars and this would trigger another wave
\nof speculative attacks on the rupiah.<\/p>\n
The central bank should also consider issuing six-month
\npromissory notes soon to supplement the one-month and three-month
\nnotes. Better still, the government could speed up its plan to
\nfloat treasury bills.<\/p>\n
These new instruments, in addition to Bank Indonesia's open-
\nmarket operations, will further diversify investment vehicles to
\ncommercial banks with excess liquidity.<\/p>\n
Quick and firm action to cope with speculative attacks on the
\nrupiah are the key to maintaining macroeconomic stability because
\nsharp rupiah depreciation always sets off a vicious circle within
\nthe economy by way of high inflation (import price inflation) and
\na high interest rate. The central bank, therefore, should be on
\nguard to stamp out any sign of speculation, however small it may
\nbe.<\/p>\n
Unless the market can be assured of the government's ability
\nto cope with inflationary pressure from the sharp fuel price
\nincrease, the rupiah will remain extremely vulnerable to wild
\nfluctuations, especially since more than 80 percent of third-
\nparty savings in banks are invested in one-month deposits.<\/p>\n
In the long run, however, the best defense of the rupiah
\nexchange rate against wild fluctuations are strong economic
\nfundamentals, which can be built up only if the general business
\nclimate is conducive enough to stimulate a robust wave of
\ndomestic and foreign investments.<\/p>",
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"sponsor": "Okusi Associates",
"sponsor_url": "https:\/\/okusiassociates.com"
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