Cavallo says rupiah debate is damaging

Cavallo says rupiah debate is damaging

BUENOS AIRES (Reuters): The public disagreement over Indonesia's plans to set up a currency board is doing little to stabilize the rupiah currency, the architect of Argentina's currency peg, Domingo Cavallo, said Monday.

"It seems to me extremely dangerous to have a public debate in the media over the introduction of a currency board as a possible solution to stabilize the rupiah and return stability to Indonesia's economy," the former economy minister told Reuters in an interview.

Cavallo, who masterminded the successful introduction of such a system in Argentina in 1991, said the debate between Indonesia's authorities on the one hand, and the International Monetary Fund on the other, "far from contributing to stabilizing the rupiah, could accentuate its volatility."

Indonesia's government looked set Monday to press ahead with a proposal for a fixed exchange system despite the IMF's tough stance against the plans.

The IMF warned Monday that Indonesia's plan could risk its US$43 billion rescue package to the country and the European Union threw its weight behind the IMF's stance.

"In my opinion, to avoid chaotic hyperinflation in Indonesia they have to find an effective form of stabilizing the rupiah at a reasonable level," he said.

Cavallo said the economic debate surrounding a currency board in Indonesia is founded on the wrong basis. The discussion about "whether currency boards reduce currency and economic volatility or not, is wrong, because they are talking about currency boards without admitting the complete logic of those systems," he said.

The key to the smooth functioning of a currency board, wherever it may be, is about the monetary authorities' willingness to adopt the "anchor" currency as the main store of value if need be, said Cavallo. Argentina's peso is pegged to the dollar at one-to-one.

"You have to think of it (a currency board) more in terms of a dollarization of Indonesia's economy than the application of a fixed exchange rate for Indonesia's currency," he said.

"Real convertibility is not being discussed, which for its existence must be accompanied by the political acceptance of the idea that in the last instance, a complete dollarization of the economy could take place," he said.

In currency board systems, the amount of domestic currency in circulation usually has to be backed up by an equal amount of foreign currency reserves.

But if reserves are being depleted and monetary authorities show the willingness to switch to the anchor currency as the main store of value in the economy, local currency interest rates will ultimately fall and confidence will return.

Some economists criticize a currency board because it leads to a loss of monetary policy to change interest rates to smooth the economic cycle. But Cavallo said this was no loss.

"I suspect that for emerging economies, the instrument of monetary policy is an extremely dangerous instrument," he said.

Cavallo said Argentina's decision to adopt a currency board involved no fully fledged debate with multilateral lending organizations.

He sent the legislation to Congress in 1991 and within two weeks it was approved by lawmakers. "It was an internal political discussion. The IMF gave its support after three months, it did not support it initially but neither did it publicly go out and criticize it," he said.