Indonesian economy not ruined

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.