IMF and RI need closer rapport

By Colm Kearney

The Indonesian government's proposal for a currency board to stabilize the rupiah has been misunderstood, and it has invoked inappropriate responses from the International Monetary Fund. The fund should raise its game by being more sensitive to Indonesia's sequencing of its reforms. The Indonesian government could more effectively reassure the international community of its commitment to real sector reform.

SYDNEY (JP): One of the key issues in economic and financial reform is the sequencing of the reforms that is, which should come first. This is a very complex issue. Financial reform is easier and quicker to implement than real reform. This does not imply, however, that foreign exchange market deregulation and floating the currency should precede real sector reform.

There are many dangers inherent in the implementation of ill- thought-through programs of economic and financial reforms. Indeed, the sequencing of the reforms can be almost as important as their content particularly during the adjustment phase. The IMF should be aware of this.

For example, the Australian government embarked upon a substantial program of financial deregulation in the early 1980s which included freeing up interest rate setting, allowing foreign banks to enter the onshore retail market, and floating the Australia dollar on the foreign exchange market. This financial deregulation preceded and outpaced real sector reform. The effects of this sequencing lead to a burgeoning current account deficit and a build-up in the country's net foreign indebtedness.

This came to a head in the late 1980's when the government was forced to slow down the pace of economic activity in order to control the current account deficit. This contributed to the worst recession since the 1930's, accompanied by very high unemployment rates. It is important to understand that although this reform sequencing was not the only cause of Australia's recession, which was worldwide in nature, it did contributed to its depth. It is also important to note that Australia now enjoys the benefits of its sweeping financial and economic reforms.

The IMF has recently demonstrated partial awareness of these issues. It has acknowledged that real sector reform takes time, and that sequencing is important. In his address to the Annual Meeting of the Bretton Wood's Committee on Feb. 13, in Washington, The IMF Managing Director, Camdessus, described the measures which will be needed to alleviate the current economic downturn in Asia. He said: "Taken together, these reforms will require a vast change in domestic business practices, corporate culture and government behavior. Of course, all of this will take time".

Later on in this speech, he also recognized the desirability of implementing "a prudent and properly sequenced liberalization". In making the latter remark, however, he was referring exclusively to capital account liberalization rather than to the broader menu of both financial and real sector reforms.

Given that he was talking about how the current economic downturn in Asia might influence the IMF's future activities, his handling of the sequencing issue was insensitive to the complexities involved in sequencing the substantial financial and real sector reforms that are on the Indonesian agenda.

The Indonesian government's proposal for a currency board (CB) should be seen as a genuine attempt to buy time on the financial reform agenda while it gets on with implementing the much-needed real sector reforms. The proposal's strength lies in its recognition of the need to secure a workable sequencing of the financial and real reforms. This aspect of the proposal makes perfect sense. The IMF's Indonesian Program did not succeed in stabilizing the rupiah, and the Indonesian government is well aware that a stable rupiah is necessary in order to facilitate the real sector reform agenda.

The CB proposal's weaknesses, however, are twofold. First, its practical application carries significant risk of failure which would further damage the rupiah and prolong Indonesia's economic hardships. Second, and more importantly, it gives conflicting signals to the international community about the government's resolve to get on with the much-needed real sector reforms.

The issue here is one of credibility rather than intent. The Indonesian government could more effectively reassure the international community of its commitment to implementing the much-needed real sector reform.

The IMF has not responded helpfully to the Indonesian government's proposal to stabilize the rupiah. It has demonstrated insensitivity to the plight of the Indonesian people and the genuine attempts of its government to stabilize the exchange rate in response to a battering from the international financial markets. It has evidently interpreted the CB proposal in a negative light as an attempt to postpone the much-needed real sector reforms.

What is the evidence for this? First, the IMF's First Deputy Managing Director, Stanley Fischer, is reported in The Jakarta Post of Feb. 14, as having criticized the CB proposal and having used uncharacteristically blunt language about political issues when he remarked that the rupiah had been hit by suggestions that the country could select a vice president whose "devotion to new ways of doing things is limited".

Second, the leaked letter from the IMF to the Indonesian government threatened to withhold disbursements of the $43 billion loan package if the CB proposal was pursued. The evidence is entirely consistent with the interpretation that the IMF has attempted to exert political pressure on the Indonesian government to sequence its financial and economic reforms according to the IMF's own preferences. This is inappropriate and unhelpful for a number of reasons.

First, it is neither a polite nor a productive way of doing business.

Second, it does not lie comfortably with the stated purposes of the organization (which can be read on its home page at http://www.imf.org/external/index.htm) which include: Article 1 (iii): "To promote exchange stability", and Article 1 (v): "To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

Specifically, the IMF's response to the CB proposal did not help to stabilize the rupiah, which was partly what the government was trying to do. Also, the threat of withholding the loan package did nothing to assist the government in its task of stabilizing the economy with minimum destruction to national and international prosperity.

Third, the IMF's preference in terms of the sequencing and timing of financial and economic reforms appears to be neither well formulated in theory nor sufficiently worked through in practice. It has demonstrated little sensitivity to the complex issues involved in implementing the Indonesian reforms. It is therefore ill-placed to justify its attempts to railroad through its own preferences. More sensitivity is required.

The moral of the story thus far is that two wrongs don't make a right. The IMF should raise its game by being more sensitive to Indonesia's sequencing of its reforms. In return, the Indonesian government could more effectively reassure the international community of its commitment to real sector reform. More specifically, I suggest the following.

(1) The IMF and the Indonesian government should sit together and come to a better understanding of each other's perspectives on the timing and sequencing of the necessary reforms. This will reduce the flow of conflicting signals to the markets and replace it with consistent signals. This will reduce the level of volatility.

(2) The IMF should attempt to be less negative and more positive in searching for an appropriate exchange rate regime for Indonesia and the region. It should initiate a regional forum of leaders to initiate talks on an Asian monetary system. Current regional exchange rate arrangements are outdated.

There is a clear need for the design of a regional exchange rate system based on an optimally weighted basket of Asian currencies, designed to minimize intra-Asian exchange rate volatility in response to variations in the world's major currencies such as the German mark and the U.S. dollar. The techniques are available to do this. All that is needed is the will.

The writer is professor of Finance and Economics at the University of Technology, Sydney. His area of expertise is macroeconomic stabilization policy and international finance. He was senior economic consultant to the Australian Federal Treasurer and the Federal Finance Minister during the early 1990s.

Window: The IMF has not responded helpfully to the Indonesian government's proposal to stabilize the rupiah. It has demonstrated insensitivity to the plight of the Indonesian people and the genuine attempts of its government to stabilize the exchange rate in response to a battering from the international financial markets.