Bud of hyper-inflation

Bud of hyper-inflation

A 12.76 percent rate of inflation last month, almost double
the general price rise in January and way above last year's 11.05
percent rate of inflation, could be the bud of hyper-inflation if
the rupiah remains weak and unstable for much longer. For
inflation to have taken such a leap when the price of most
staples was still subsidized leaves people understandably
apprehensive of what will happen when those subsidies are one by
one repealed.

The government is bound by its long-term commitment to reform
to cut subsidies, beginning next month with fuel oil and
electricity. Sugar and wheatflour will follow shortly, as the
government has said that the price of these two commodities will
be set on the open market. A large part of the demand for these
commodities is met through imports and so when subsidies are
removed, another huge wave of inflationary pressure may sweep
through the economy.

That nothing more rapidly unsettles an economy than currency
devaluation with attendant inflation is the blunt message once
again being driven home. In this context, President Soeharto has
conducted a near-obsessive search for a quick fix solution to the
volatile, downward plunge of the rupiah, which has since July
last year lost over 70 percent of its value against the American
dollar.

The battered rupiah and high inflation have been eating away
at the purchasing power of most wage earners at the same time as
many business ventures have folded and many, many more are on the
verge of bankruptcy. Worsening lifestyles and job insecurity have
made people restless, nervous and highly susceptible to believing
wild rumors. The catalyst for January's panic buying episode was
uncertainty over food availability. People did not know if they
would be able to eat in the days following the incident.
Uncertainty was also responsible for severe shortages of several
basic commodities last month, and that despite the fact that
domestic production capacity is more than adequate for current
domestic demand.

It is difficult to imagine what might happen next month, when
the government begins to reduce subsidy spending and a further
wave of price rises hits the population at large. The social and
political situation could be destabilized, causing the whole IMF
reform package to be removed from the national agenda. The nation
would have to struggle for its very survival.

Top priority must be given to restoring immediately the
stability of the rupiah, something that the IMF package is
unlikely to deliver. That is why President Soeharto has been
mulling over what he believes to be the most promising solution,
or perhaps salvation -- a fixed exchange rate under a currency
board system (CBS).

The advantages and disadvantages of CBS have been exhaustively
debated since early last month. We feel that the President and
his team of advisers have now had more than enough inputs to be
able to decide on the most appropriate option for Indonesia.

Whatever arrangements are made to stabilize the rupiah
exchange rate, the move would be unlikely to carry any
credibility unless immediately supported by a more concerted
effort to address the crisis in public confidence in the
government.

The President acknowledged the paramount importance of
restoring confidence in his accountability speech on Sunday and
conceded that the loss of confidence was the primary cause of
"the numerous difficult problems we are encountering today".
Unfortunately he did not magnanimously cite the reasons behind
the loss of confidence.

In introspection, it is worthwhile to recount that when the
government first called in the International Monetary Fund last
October for assistance it was then heralded as a preemptive
bailout program to boost confidence.

But what we are now painfully enduring is a self-perpetuating
overreaction by the foreign exchange and financial markets caused
by the government's failure to deal with the economic situation
before a full blown crisis had developed. When the first IMF
reform package of Nov.1, 1997 was broadened and rewritten on Jan.
15, it appeared as though the government was implementing the
reforms under duress. This inflicted a greater damage -- one from
which recovery will be slower.

There is no quick solution to regaining confidence, or to
ending the currency crisis. Confidence is earned through
prudence, wise policies backed up by efficient and consistent
implementation and fair and honest conduct. These principles are
the basic elements of good governance. Without the support of
public confidence, any fixed exchange rate regime will lack
credibility. It might be effective in the short term, but only
momentarily, buying a small amount of time before the foundations
of our modern economic system collapsed.