IMF and RI need closer rapport

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.