Credible fixed rate 'vital to CBS success'

JAKARTA (JP): The biggest questions Indonesia has to answer before adopting the currency board system (CBS) are at what fixed rate will the rupiah be pegged to the U.S. dollar and which money category will be covered by the system, a director at Bank Indonesia has said.

Miranda Gultom told a seminar yesterday that the key to the success of the CBS was the credibility of its fixed foreign exchange rate.

"That is because every demand (on the U.S. dollar) must be honored," she said at the meeting organized by the Golkar faction of the House of Representatives.

She added it was very crucial that the CBS be based on a special law to strengthen its credibility and autonomy.

She said a pegged exchange rate regime used by the central bank before it wholly floated the rupiah last August did not have to be supported by a special law since the central bank could still intervene in the foreign exchange market to influence the exchange rate.

"Under a CBS, such a move is not possible," she pointed out.

Finance Minister Mar'ie Muhammad confirmed at a meeting with the House of Representatives on Wednesday that the government was finalizing the legal and institutional frameworks for the introduction of a CBS to stabilize the rupiah rate.

The rupiah has strengthened against the dollar after the government declared it would set up a CBS. The currency rose from the 9,000 level last week to a range of 7,400 to 7,600 this week.

A CBS is a monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.

The CBS idea surfaced last week after President Soeharto was briefed by U.S. economist Steve Hanke on the advantages of Indonesia implementing a currency board arrangement to stabilize the shattered rupiah.

Miranda added that another key question in preparing the CBS was which of the money categories -- M1 (bank notes, coins and demand deposits) and M2 (M1 plus time deposits and similar instruments) -- would be covered, taking into account the government's foreign reserves of US$19 billion.

She explained that the M1 supply now totaled Rp 73 trillion and the M2 supply totaled Rp 378 trillion.

She said if the rupiah was fixed at 5,000 to the American dollar with only M1 covered, then only $14 billion in foreign reserves would be required to match the currency. But if the fixed rate was designed to cover M2, at least $80 billion in foreign reserves would be needed.

"Bank Indonesia and the finance ministry are now addressing these questions," she said.

In Washington, a spokesman for the International Monetary Fund (IMF) said the fund was holding talks with Indonesia concerning the "the requirements for the successful use of a currency board arrangement".

"These discussions are likely to be going on for some time and we have nothing firm to say for the time being," the spokesman was quoted by AFP as saying Wednesday.

However, U.S. Treasury Secretary Robert Rubin on Wednesday displayed little enthusiasm for Indonesia's CBS plans.

Rubin made no secret of his reservations, telling reporters following a Congressional hearing that Indonesia must deal with "a lot of issues" before it considers a currency board.

"I think the focus right now ought to be on the other issues that you have to work through before you even get to the question of a currency board.

"I think there are issues with respect to the banking system. I think there are a lot of other issues that go to the question of having credibility adhering to reform programs, having the credibility in the financial markets that I think underpin a currency board."

Jakarta's plans to follow the Hong Kong model and set up a currency board to stabilize the rupiah, which has been battered by the Asian financial crisis, have been met with criticism by many economists.

A major Australian bank added its voice yesterday to doubts about a fixed exchange rate for the Indonesian currency.

Commonwealth Bank of Australia managing director David Murray said a peg to a foreign currency could boost short-term confidence in Indonesia but would not cure the rupiah's ills.

"It may be okay for some time but in the long term there's no good argument for fixing exchange rates," he told reporters after delivering a speech in Melbourne.

In the short term, a fixed exchange rate could give Indonesian companies greater certainty in trying to repay foreign currency debt and also restore some price stability, he said.

"But, over the long term, there's not much point," Murray said.

But Neil Saker, head of regional economic research for SocGen- Crosby in Singapore, said Indonesia's CBS plan is the last chance for the country to stop its currency from a free fall.

"This is the last chance. It has to be supported totally. There is no option," Saker told a news conference on Asia's economic crisis. (08)