The currency board system<\/p>\n
President Soeharto's fast, bold move on a fixed exchange rate
\nsystem under currency board arrangements, to arrest the wild
\nvolatility and downward spiral of the rupiah, is founded strongly
\non both economic and political rationale.<\/p>\n
Without a stable currency, nothing else will stabilize and
\nimprove the economy. Instead, a shattered rupiah will drive most
\ncompanies into bankruptcy, increasing the unemployment ranks to
\nan explosive level, raising prices beyond the purchasing power of
\nthe people and triggering social and political instability.<\/p>\n
A fixed exchange rate, if the experiences of other countries
\nsuch as Argentina, Hong Kong, Brunei, Bosnia, Estonia and
\nLithuania are any guidance, could quickly solve almost all the
\nproblems caused by a wildly fluctuating currency.<\/p>\n
A currency board system (CBS) creates a stable exchange rate
\nbecause every unit of local currency is backed by the equivalent
\nin the chosen anchor currency. Any increase in the domestic
\ncurrency in circulation should be matched with foreign reserves.<\/p>\n
However, whether a CBS is the best way for Indonesia to get
\nout of the present crisis is still highly debatable, given the
\nwide differences between our circumstances and the countries
\nwhich have successfully implemented the system.<\/p>\n
Not many technical details were immediately available as to
\nhow the government would organize and structure its CBS for the
\nrupiah. But, given the short time available to prepare all the
\nlegal and technical frameworks, we reckon that the CBS would
\nlikely be established as a division within the central bank (Bank
\nIndonesia).<\/p>\n
Setting up a separate monetary institution outside Bank
\nIndonesia would require amendments to the Central Bank Law, a
\nprocess that may take a few weeks even though the House of
\nRepresentatives is dominated by the ruling Golkar organization.<\/p>\n
The consequence of the introduction of CBS is that the
\ngovernment will have to surrender virtually all its monetary
\npolicy autonomy.<\/p>\n
The government would no longer be free to set interest rates
\nand inject liquidity into the economy at will. Asset markets,
\noutput, employment and other economic aggregates must adjust to
\nwhatever levels are required to maintain the specified exchange
\nrate. If companies or banks go bankrupt they can not be bailed
\nout.<\/p>\n
Given the rigid market discipline CBS requires, the biggest
\nquestion -- or rather the greatest doubt -- is whether such a
\nsystem could be credible and sustainable for a long time under a
\npolitical leadership, notoriously known for its high
\nvulnerability to cronyism, nepotism and corruption.<\/p>\n
The advocates of CBS see this fixed-rate system as the
\nquickest way of getting out of the currency turmoil, arguing that
\nthe country's official foreign reserves are more than enough to
\nback up such a system.<\/p>\n
Critics and skeptics, however, argue that while the US$17
\nbillion in official foreign reserves might be adequate to support
\nCBS -- depending on which level the rate would be fixed and which
\nmoney category would be covered -- two key fundamentals for a CBS
\nsuccess do not yet exist in the country: a sound banking system
\nand strong public confidence in the political leadership's
\ncapability and willingness to consistently take painful reform
\nmeasures to cope with the economic crisis.<\/p>\n
CBS is only as good as the intentions of the people who create
\nand operate it. Doubts about the motives behind introducing CBS
\nwould remain until the government is seen to act firmly on its
\nprevious commitments. The people should be convinced that the
\ngovernment does not fiddle with the system.<\/p>\n
The question is how the government could convince the people
\nthat CBS would really be free from political interference, unlike
\nthe central bank, which has so far been highly vulnerable to
\npolitical intervention and politically well-connected vested
\ninterests.<\/p>\n
Confidence is a precious commodity. Once lost, it is difficult
\nto regain.<\/p>\n
The value of the currency and financial intermediation process
\nin particular are built on confidence, the trust that deposits
\nare safe, bonds are redeemable, contracts are binding and
\nenforceable.<\/p>\n
Take this vital pillar away, and the entire structure
\ncollapses with devastating consequences for the economy.<\/p>\n
If the people do not fully believe in CBS there might be a
\nmassive scramble for dollars to cash out of rupiah as quickly as
\npossible. This would worsen the credit crunch, leading more
\ncompanies into bankruptcy, as rupiah interest rates would
\nskyrocket to several hundred percent.<\/p>\n
In anticipation of such a scramble for dollars the CBS should
\nbe backed up by reserves equivalent to the broad money supply
\n(estimated at Rp 378 trillion) to make it credible. Obviously,
\nour foreign reserves would not be sufficient to support it.<\/p>\n
IMF endorsement is also vital for gaining the international
\nmarket confidence in CBS but as IMF First Managing Director
\nStanley Fischer stated in Washington on Thursday, CBS was not
\nviable for Indonesia at this juncture in time.<\/p>\n
The government is faced with extremely difficult choices. It
\ncould accelerate the process of stabilizing the rupiah by acting
\nmore firmly and speedily on the IMF-arranged reforms and
\nstrengthen this effort with equally bold political reforms to
\nregain confidence.<\/p>\n
Or the government could push ahead with its plan on CBS at
\ngreat risks because the new system will not only require
\nwholesale renegotiation of the IMF rescue package of Jan. 15 but
\nalso may delay the next disbursement of the second $3 billion
\nfund from IMF, scheduled in the middle of next month.<\/p>\n
But the sheer renegotiation of the Jan. 15 package, after the
\nbad image and low credibility already incurred by the
\ngovernment's backtracking on the Nov. 1 package, would not help
\nthe process of confidence building.<\/p>",
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