Indonesian economy not ruined
By C.J. de Koning
This is the first of two articles on the Indonesian currency.
JAKARTA (JP): Money provides power -- the power to purchase goods and services and the power to save. Many individuals, corporate treasurers and finance ministers would like to have more money at their disposal.
Money determines whether families or countries can feed themselves or must starve. Money carries risks -- positive risks if money is well managed, and negative risks, which have the power to destroy economies.
Indonesia uses its own money, the rupiah, but also avails itself of money earned, borrowed or invested from abroad. This money comes mostly in the form of U.S. dollars.
Since 1967 Indonesia has had an open economy in which the rupiah was, and is, fully convertible into dollars and vice- versa. It is thus a good example of a dual currency country. Furthermore, regarding external trade, Indonesia has become increasingly integrated into the global economy.
A strategy to analyze and respond to unforeseen events is needed to manage the risks of a dual currency economy. Events of the last year have starkly demonstrated this need as the country lurched rudderlessly between shocks regarding the exchange rate, the growth rate, inflation and the corporate and banking sectors.
The analysis required to develop responses to such shocks must start from the dollar side. The flows of dollars into and out of a country are usually measured with the help of balance of payments statistics.
The balance of payments is calculated by measuring the value of visible exports and imports throughout the year. The difference between visible imports and exports is known as the balance of trade.
To this is added net earnings from the invisible sector of the economy. The invisible sector consists of intangible flows into and out of the country such as technology transfers and services.
Interest payments on foreign loans are sometimes included in the invisible sector and sometimes under a third category known as capital flows. In the analysis below they are excluded from invisible, or net service, earnings.
Net visible earnings, net invisible earnings and net capital flows together make up the balance of payments.
The following analysis uses the Ministry of Finance's most recent balance of payments projections for the 1998/1999 fiscal year and assumes a total of 250 banking (working) days in the country.
Finance ministry projections when divided by the number of banking days suggest that Indonesia has the following average daily cashflow:
Daily export income : + US$226 million
Daily import expense: - US$152 million
Daily net services expense (excluding interest expense): - US$ 16 million
Disposable daily income : US$ 58 million
Assuming 250 banking days in a year means this translates into an annual disposable income of $14.5 billion.
Between July 1997 and June 1998 an estimated $90 billion left the country in what was nothing short of a stampede of capital.
The Jakarta Post in a previous article attempted to establish the source of this outflow. Tentative estimates suggest that foreign investors withdrew $30 billion from the Jakarta Stock Exchange, $30 billion in principal and interest payments on loans were transferred to foreign banks, $9 billion was absorbed by trade finance deals, Indonesian citizens sent $10 billion overseas, and open currency positions adopted by local banks and companies accounted for a further $10 billion.
Many of these events were one-off in nature and the likelihood or possibility of them ever happening again is very slim. Furthermore, these estimates are very approximate in nature because no accurate measurement of these outflows was made.
However, assuming $90 billion is correct and that dollar demand was spread evenly across the 250 banking days between July 1997 and June 1998 then there was an average daily dollar demand of $360 million.
This hefty sum when offset against the nation's daily disposable income of $58 million leaves an average financing gap of $302 million for each banking day over that period.
Evidence from the past 12 months (particularly the second half of that period) demonstrates clearly that this gap could not always be met and as a consequence the rupiah-dollar exchange rate tumbled far below its market value based on real sector flows alone.
That the rupiah could fall victim to these massive capital flows clearly demonstrates the negative power of money. Flows of capital out of the country caused the rupiah to overshoot its desirable exchange rate of Rp 5,000 to the dollar. This caused the cost of imports to soar and brought in imported inflation -- the main source of the country's current inflationary woes.
Furthermore, the price of many Indonesian goods are closely linked to world market prices and so a substantial undervaluation of the rupiah also resulted in higher local price levels.
Many banks, companies and institutions in the country (including the government itself) held open currency positions when the crisis broke. Their respective financial circumstances therefore deteriorated with every incremental slip in the value of the rupiah.
At a conservative estimate less than half of Indonesia's total foreign currency liabilities were covered against exchange rate volatility, so it is not difficult to visualize the damage which the rapid drop from Rp 5,000 against the dollar to Rp 15,000 had on the country.
Overshooting the exchange rate creates all kinds of economic problems which act to perpetuate each other and which are fueled by disincentives to retain funds in Indonesia under such circumstances. Thus the problems reinforce each other rather than reduce pressure on the currency.
The conclusion is that even under the current circumstances, a rupiah-dollar exchange rate of Rp 5,000 should be the target rather than Rp 10,600. The sooner the rupiah returns to this level, the smaller the damage caused by the overshoot will be. At the Rp 5,000 level, Indonesia's real sector would still be very competitive on the international stage.
The key question is, of course, how does one achieve this?
Foreign operators in the Indonesian economy view their risks from a foreign currency point of view rather than in local currency terms. Any strategies drawn up to attract foreign investment back into the country -- be it in the form of loans, equity participation, real estate or on the Jakarta Stock Exchange -- must therefore aim to reduce the risks associated with participating in the Indonesian economy.
There are four types of risk that can be reduced. The first concerns lending foreign currency. The second concerns payment and settlement. The third is local counter-party risks and the fourth is the risk that abrupt withdrawals of capital will again cause the rupiah to overshoot its desirable exchange rate on the basis of real sector transactions.
The writer is Indonesia country manager for ABN AMRO Bank. He has written this article in a private capacity.