Desperate move
Bank Indonesia (BI) raised its benchmark interest rates across the board again to as high as 58 percent last Thursday in another concerted bid to rebuild confidence in the rupiah and to curb inflation, which has exceeded 33 percent in the last four months alone. It is a desperate move to cope with a desperate economic situation which has seen the rupiah collapse again to almost 10,000 against the U.S. dollar, its lowest rate since mid-March. The rate stood at 2,450 last July.
While the measure will surely precipitate more business failures with massive worker layoffs and may drive more banks into insolvency, its positive impact on the rupiah remains in doubt since the economic crisis has been exacerbated by a political crisis which is eroding the legitimacy of the government. In fact, the risks of more social unrests and political instability have now become the primary determinant of the rupiah's rate.
The rupiah had started stabilizing at a range of 7,800 to 8,000 against the dollar from as low as the 17,000 mark in January after the central bank first increased its certificate rates on March 21. The currency strengthened again at a higher band of 7,750 to 7,900 immediately after BI's second rate increase to as high as 50 percent on April 21.
Had it not been for the recent social riots and massive looting in the North Sumatra capital of Medan and its surrounding towns in the first three days of last week, the rupiah should have strengthened significantly after the country received a strong vote of confidence from the International Monetary Fund's (IMF) executive board early last week.
The IMF's board of directors unanimously concluded at its May 4 evaluation meeting in Washington that Indonesia had fully met reform targets set for that period. This acknowledged an impressive performance after the government's previous backslidings on both its Nov. 5, 1997 and Jan. 15, 1998 reform agreements with the IMF.
The IMF decision to release its second US$3 billion tranche -- though in three monthly installments instead of a lump sum as its first $3 billion tranche was disbursed in November -- should have reinvigorated market confidence in the government's commitment to reform. The IMF move will also soon unlock $6 billion in loans from the World Bank, the Asian Development Bank and several other country donors participating in the $43 billion bailout fund for Indonesia established in early November. But the rupiah remains vulnerable.
This anomaly is bringing home the warnings -- made repeatedly by analysts, politicians, intellectuals, students and the mass media over the last few months but stubbornly rejected by the political leadership -- that economic measures alone, though necessary, are no longer enough to cope with the crisis.
BI Governor Sjahril Sabirin himself conceded when announcing the rate increase that the measure in and of itself was not enough to beef up the rupiah because the economic crisis had been complicated by what he called noneconomic factors. But Sjahril remains convinced that the interest rate policy is the most effective instrument in the central bank's arsenal to prevent the rupiah from further spiraling downward. The April 21 rate increase, for example, succeeded in generating $1.78 billion in capital inflows through foreign purchases of BI's certificates.
Fears nevertheless are rising over the perception that a slow, lukewarm response by the national leadership to the increasing demand for political reform would only make people more restless and increasingly impatient over current economic hardships. Since the people's sufferings will likely increase before the economy begins to stabilize, tempers could easily flare and explode into nation-wide violence.
The massive riots in North Sumatra could be a last warning to the government to act quickly, firmly and consistently in addressing the demands for political reform to establish good governance. Without solving the fundamental political issues of the crisis, the government's painful reform measures, including last week's fuel and electricity price increases, will not bring the rupiah to a level strong enough to stop the country's economic bleeding.