Argentine peso peg a tough lesson for RI

Argentine peso peg a tough lesson for RI

BUENOS AIRES (Reuters): The currency system Indonesia is considering has been a resounding success in restoring economic stability in Argentina but has also contributed to some tough times.

Indonesia's President Soeharto is looking to the same currency system that Argentina introduced in 1991 when it fixed the peso to the dollar to end decades of hyper-inflation and set a course for strong economic growth.

Argentina's system obliges the central bank to have one dollar in reserve for every peso in circulation. The more foreign investment there is, the more dollars there are at the central bank and the more pesos there are in circulation to fuel economic growth.

But this also makes the country vulnerable to external shocks and underlines the need for wholehearted commitment to such a system. The 1995 "Tequila" crisis, prompted by a rash devaluation in Mexico, pushed the country into severe recession and unemployment to record levels as dollars were pulled out of the country.

Under the so-called Convertibility plan of 1991, monetary policy has all but disappeared with no ability by authorities to massage the economic cycle with interest rates.

On the other hand, Argentina now has one of the lowest inflation rates in the world (0.3 percent in 1997), foreign investment has surged and the country's long-term prospects have vastly improved.

Argentina's convertibility plan showed that "if you have a bad track record, you have to take drastic measures," said Adrian Broz, an economist at Deutsche Morgan Grenfell Global Markets Argentina.

Pegging your currency at a set rate to an "anchor" currency is not just a one-off exercise. It is an attempt to create long-term expectations of economic stability.

Argentina's instability came from its years of chronic economic mismanagement which pushed annual inflation to a high of 5,000 percent in 1989.

Indonesia's economic woes landed with a spiraling Asian currency crisis. At one stage the rupiah fell 80 percent to the dollar from its pre-crisis levels. The collapse in the rupiah left most Indonesian companies technically bankrupt, with private foreign debt put at over US$73 billion.

Argentina adopted policies that complemented the peg and improved credibility. Mass privatizations, tough deficit-cutting measures and banking reforms are but a few.

The government showed its commitment by preferring to ride out the 1995 recession rather than scrap the board. Despite the economic storm, Argentines showed their support for President Carlos Menem and the system by reelecting him in a landslide vote in 1995.

The government once again demonstrated its determination to stick by the system last year, saying a recession is preferable to a dumping of convertibility if Asia's crisis hits Latin America hard.

Vladimir Werning, an analyst at JP Morgan in Buenos Aires, added that "besides credibility you will also have to have transparency. Investors will want to monitor the currency board." To do that Argentina's central bank daily publishes the level of its foreign currency reserves.

But a currency board requires "more discipline than any system of a fixed exchange rate," said Jose Luis Espert, director at the Econometrica financial consultancy. "People do not consider how large the costs are."

And analysts suggested Indonesia may not be as badly off as Argentina was.

"A country (Argentina) that had four periods of hyper- inflation is not the same as one (Indonesia) which is having its first crisis in 20 years," said Espert.

The International Monetary Fund has warned that Indonesia is not ready yet for this system, saying it must first introduce economic reforms.

However, analysts said, the IMF was initially hesitant over Argentina's plans as well.