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.