Has the IMF reform package failed?

Indonesia has implemented the International Monetary Fund reform package but the value of its currency continues falling. Economist Kwik Kian Gie discusses the reason behind the rupiah's decline.

Question: The value of the rupiah fell to Rp 4,020 against the U.S. dollar on Friday in spite of the IMF package. What is your comment?

Answer: The IMF reform package has failed to help stabilize the rupiah's value. When the rupiah originally fell to Rp 4,000 per dollar the government was desperate and lost confidence in whether it would be able to overcome the monetary crisis and economic troubles and it, therefore, sought assistance from the IMF. Now the psychological barrier of Rp 4,000 per dollar has been passed five weeks after the IMF package was announced.

Soon after the government and the IMF announced their agreement on Oct. 31, the rupiah strengthened to Rp 3,200. But, in spite of Bank Indonesia's market intervention everyday, it has since steadily declined to Rp 4,020 on Friday. In the coming days, the exchange rate will probably be regarded as normal if it hovers at around Rp 4,000 per dollar.

Q: You said Bank Indonesia intervenes in the market everyday. Why doesn't the intervention help?

A: Bank Indonesia itself has never explained its market intervention. We know of it only from press reports and bulletins distributed by big banks to their clients. Only after being queried by members of the House of Representatives, did Bank Indonesia Governor Soedradjad Djiwandono admit that the central bank had intervened. But he hastily explained that the intervention was not aimed at defending the rupiah at a certain level, but in preventing the value from declining excessively.

Q: Does it mean that the central bank should stop intervening?

A: Minister of Finance Mar'ie Muhammad recently said in Kuala Lumpur the government would no longer intervene in the market. But newspapers still reported that Bank Indonesia was continuing to intervene in the market to prevent the rupiah from surpassing the Rp 4,000 level. So there was confusion between the minister's statement and the action of the central bank.

Q: What is the rupiah's fate if there is no intervention?

A: Nobody knows. What is clear is that the public need not expect too much from market intervention because it clearly does not help. The important thing is getting an estimate on a proper conversion rate for the rupiah.

The calculation of purchasing power parity (PPP) by The Economist shows that the rupiah should have been worth Rp 1,818, implying that the rupiah is now undervalued.

Q: Isn't the PPP calculation too simple?

A: Yes. The Economist itself admits it.

Suppose we correct the figure Rp 1,818 and replace it with Rp 2,400 per dollar, a conversion rate of Rp 4,000 means that the rupiah is still undervalued by 67 percent.

Q: How can the PPP and the real conversion rate deviate so much?

A: Because there are two other factors that influence the rupiah's value -- the psychological and demand factors.

The psychological factor indicates that people do not believe in rupiah's stability. They believe that the rupiah will continue falling and they hastily buy dollars. The demand factor shows that the demand for dollars is higher than supply.

Q: To help reduce demand, big businesspeople, accompanied by the Minister of Finance, are going abroad to ask for their foreign debts to be rolled over. Will this really help?

A: Maybe it will help a little. Businessman Sofjan Wanandi has said that foreign creditors would not likely confiscate their collaterals and opt to roll over their loans.

I don't think that it is necessary for Indonesian borrowers to go abroad together on a road show. Just fax letters saying: "We cannot repay our debts, what do you suggest we do?"

Q: What would be the impact if Indonesian borrowers do this?

A: Whether such defaults are accompanied by long explanations or rough confrontation, the impact will be the same -- no foreign investments will enter Indonesia for a long period of time and Indonesia's country risk will increase sharply.

Q: How long will foreign investors stay away from Indonesia?

A: At least for two to three years.

But in any case, the country's balance of payments will be under pressure and foreign exchange reserves will run low. The government, therefore, is likely to use the $30 billion aid from the IMF and bilateral arrangements to deal with the current account deficit.

Q: Doesn't that mean that everything will be solved?

A: Not really. By using the $30 billion, Indonesia's foreign debt will increase by that much and the savings-investment gap will expand. So, the gamble for Indonesia is whether or not it will be able to eradicate corruption, collusion and nepotism.