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.