Indonesia Incorporated: Dream or reality?

Indonesia Incorporated: Dream or reality?

By C.J. de Koning

This is the first of two articles on the capricious value of
the Indonesia's currency.

JAKARTA (JP): In the discussions about a desirable rupiah-U.S.
dollar exchange rate, nearly all focus is on the price element of
the exchange rate. The price of the rupiah stands for its value
within Indonesia.

In business such prices play a highly important role. For
instance the price of sugar was Rp 1,400 per kilogram in June
last year. Now after the rupiah exchange rate adjustment and
after the abolition of the sugar monopoly two things happened.

Firstly there is an international price for sugar, say US$
0.53 per kilogram. The Indonesian producer currently has the
choice of export or sell to the local market. If exports yield Rp
5,300 per kg then he will export, at an exchange rate of Rp
10,000 to one U.S. dollar. But if the local price rises to say Rp
5,200 per kilo he will sell locally (no shipping costs, therefore
somewhat lower price).

If the rupiah-dollar rate would be Rp 5,000 to the dollar the
international price of sugar of US$0.53 per kilo would have
translated into a local price of Rp 2,650 per kilo.

For many, many products there are strong links between the
Indonesian domestic and the international price levels. If the
rupiah depreciates and international prices stay the same,
domestic rupiah prices are adjusted upwards.

Local values, expressed in local currency increase
dramatically when the rupiah depreciates substantially. For
Indonesia it does not matter whether it is rice, cooking oil,
sugar, wheat, milk powder, plywood, iron ore, oil and gas,
aluminum or many other raw materials, semi finished or finished
products or capital goods.

The fact is that international prices set the guiding sales
price for the Indonesian market via the rupiah-U.S. dollar
exchange rate applicable at the transaction day. Indonesia has
become part of the world economy.

Indonesia for price fixing uses mostly the rupiah. However,
there are quite a few exceptions, for instance many rents are
quoted in dollars, most auditing firms send U.S. dollar invoices,
and importers of more expensive capital goods do the same, so do
power plant operators, and oil and gas exploration companies to
mention just a few.

A currency board system basically fixes the price element of
the exchange rate, by attempting to maintain such a rate at say
Rp 5,000 to the U.S. dollar. For price fixing a CBS makes perfect
sense.

However, there is another element determining the rupiah-
dollar exchange rate. This element is linked with the foreign
currency cash flow. This cash flow represents foreign currency
earnings of Indonesia as a country: Indonesia Inc. This cash flow
is further linked with foreign currency savings and loans, and
foreign currency investments and debt servicing flows.

On the foreign currency income side, Indonesia for its exports
applies international prices, its export quotes are nearly all in
U.S. dollars. Also in the import trade mostly U.S. dollars are
used and not the rupiah. Its foreign exchange earning capacity is
nearly all in U.S. dollars.

On the savings and loans side, the amazing thing is that
Indonesia is also using the U.S. dollar much more widely than the
rupiah. For instance Indonesians when they save, many of them
save in U.S. dollars, or other foreign currencies, rather than in
rupiah.

Nearly all banks in Indonesia operate such foreign currency
accounts, both for savings and time deposits. Indonesia's local
deposit base is therefore a mixture of rupiah and foreign
currency deposits. The total banking assets (including foreign
currency accounts) of banks in Indonesia is approximately US$ 37
billion at Rp 10,000 to one U.S. dollar.

It gets even more interesting by considering the overseas
savings. Indonesians have -- according to private banking
estimates -- some US$ 120 billion in funds overseas, in the U.S.,
Canada, Hong Kong, Singapore, Switzerland, U.K., Luxembourg, the
Netherlands and other countries. So most Indonesian savings, more
than 80 percent in volume terms, are in currencies other than the
rupiah.

On the loans side, the picture is identical. Domestic loans
tally with the assets of the local banks, i.e. US$37 billion most
of which are in rupiah, some in U.S. dollars. Sourcing loans in
the domestic market in rupiah via the capital market represents
only a small fraction of the banking market.

However, U.S. dollar and other foreign currency loans stand at
US$137.4 billion, not counting the IMF package. Again the use of
foreign currencies in local borrowings is by far exceeding the
rupiah use at least by a factor of 4:1; surprisingly enough more
or less equal to the savings picture, but of course with
different parties involved.

The question to ask is: Has the rupiah exchange rate pressure
started from the rupiah side or from the U.S. dollar side?

Evidence suggest it is from the U.S. dollar side rather than
from the rupiah side.

Drs. C.J. de Koning is Country Manager Indonesia for ABN-AMRO
Bank.