The target is low inflation, not a specific exchange rate<\/p>\n
Vincent Lingga, Jakarta<\/p>\n
The inflationary pressures resulting from the 29 percent
\nincrease in fuel prices in March seem to have receded, as can
\nbe seen from the significant decline in the inflation rate last
\nmonth to 7.40 percent, on an annual basis, from 8.12 percent in
\nApril.<\/p>\n
However, the finance ministry apparently agrees with the
\ncentral bank (Bank Indonesia)'s analysis that the assumption for
\nthe rupiah exchange rate for the current fiscal year should be
\nrevised to a range of between Rp 9,000 and Rp 9,300 from the
\noriginal projection of Rp 8,900 made last August. Meanwhile, the
\ninflation assumption is to be revised upward to an average 8
\npercent.<\/p>\n
The revised assumptions have been made necessary because the
\naverage rupiah exchange rate in the first five months of this
\nyear had depreciated to almost Rp 9,400. In fact, the local unit
\nfell to as low as Rp 9,800 against the American dollar late in
\nApril.<\/p>\n
This development raises two major questions.<\/p>\n
Does it mean that the central bank will now target the rupiah
\nexchange rate at a specific level?<\/p>\n
Then, why have rupiah exchange rate movements not matched the
\nsignificant improvements that have taken place in political and
\nmacroeconomic stability, especially after the peaceful, clean and
\nfair legislative and presidential elections last year?<\/p>\n
Bank Indonesia's Senior Deputy Governor Miranda Goeltom gave a
\n\"definitive no\" to the first question on Thursday.<\/p>\n
\"We cannot target our exchange rate. Our target or objective
\nis low inflation,\" said Miranda at business luncheon hosted
\njointly by the Indonesian French Chamber of Commerce and
\nIndustry, the Indonesia-Netherlands Association (INA) and
\nEurocham.<\/p>\n
That means that the rupiah will be allowed to move within a
\nmarket-determined mechanism whereby Bank Indonesia uses its
\ninstruments to achieve low inflation by taking the exchange rate
\ninto account.<\/p>\n
Put another way, the central bank will manage the exchange
\nrate with the primary objective of ensuring low inflation as
\nexchange rate movements directly influence inflation through
\nhigher import prices.<\/p>\n
After all, it is virtually impossible to have a stable
\nexchange rate in a country with an open-capital account and
\nfloating exchange-rate system.<\/p>\n
But why has the rupiah not appreciated since January despite
\nthe significant improvements in economic fundamentals and
\npolitical stability?<\/p>\n
Miranda cited inflationary pressures and a lack of supply of
\nforeign exchange as the main reasons.<\/p>\n
Lack of supply seemed to have been a common phenomenon,
\nespecially after the sizable increase in new investment over the
\nlast four months, as reflected in the almost 34 percent rise in
\nimports during the January-April period, notably imports of
\ncapital goods.<\/p>\n
This seems rather an unusual phenomenon. But this trend
\nindicates that investment expansion has been derived mainly from
\ndomestic investors, not from foreign direct investment.<\/p>\n
Inflationary pressures due mainly to the March increase in
\nfuel prices had prompted the central bank to soak up excess
\nliquidity in the market by steadily raising its short-term
\ninterest rate to as high as 8 percent now, thereby curbing the
\nmovement from rupiah to dollar assets.<\/p>\n
Dollar assets have offered higher returns after the U.S.
\nFederal Reserves increased its Fed funds rate to 3 percent now.<\/p>\n
However, managing the exchange rate through either direct
\nmarket intervention (increasing foreign exchange supply) or money
\ntightening appears to be a delicate balancing act for the central
\nbank.<\/p>\n
\"We don't want to go to the market just to meet the private
\nsector's demand (for foreign exchange)\", Miranda said.<\/p>\n
That means that Bank Indonesia will not intervene in the
\nmarket if it believes that the increase in demand was caused
\nmainly by \"unexplained factors\" (such as an increase in demand
\nnot supported by underlying transactions, meaning speculative
\ntrading).<\/p>\n
\"We are monitoring the market very closely and our capability
\nto analyze the supply and demand movements have much improved,\"
\nshe added .<\/p>\n
Further down the line, it suggests that the central bank will
\nintervene only if it comes to the conclusion that there really is
\na genuine gap between supply and demand that can be explained
\nbased on structural factors, such as in case of state-owned oil
\ncompany Pertamina's need for foreign exchange to import oil.<\/p>\n
The government and central bank agreed late in April that
\nPertamina, which needs large quantities of foreign exchange for
\nits daily operations, and other major state companies should
\ncoordinate their dollar purchases with the central bank to
\nprevent shocks in the market.<\/p>\n
Bank Indonesia has been criticized or misperceived by analysts
\nand market players as often being caught on the hop or being too
\nlate in defending the rupiah.<\/p>\n
But as Miranda explained,\"We don't want to let unexplained
\nfactors in exchange rate movements pass into the inflation rate.\"<\/p>\n
Unexplained factors include an increase in demand that is not
\nsupported by underlying transactions.<\/p>\n
In the long run, however, Miranda believes that the best way
\nto save the rupiah from wild volatility is to woo foreign direct
\ninvestment and increase exports.<\/p>\n
This means that economic fundamentals should be strengthened
\nby improving the general business climate to stimulate robust
\ndomestic and foreign investment.<\/p>",
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