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was still subsidized leaves people understandably apprehensive of what will happen when those subsidies are one by one repealed.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.