Indonesia's peg mirage
If, in his anxiety to find a solution to Indonesia's financial crisis, President Soeharto presses ahead with plans to peg the rupiah to the U.S. dollar, he is likely to find himself exchanging crisis for disaster. The policy looks bound to fail, particularly if it goes into action before stability is restored to the country's economy. Such a strategy would affect the whole region, and could deal a crippling blow to the fragile recovery now under way.
It would be extremely difficult for Jakarta to prove it is fully committed to the responsibilities of a linked exchange rate system. The government has been slow to start on crucial reforms. Faced with a fragile banking system and a high interest regime, the only way out of its problems is by following measures imposed by the International Monetary Fund and the World Bank.
Indonesia must pursue policies of tight money and fiscal austerity, and stop the central bank printing money to bail out other bankrupt banks. Quick fix solutions for political purposes will only make matters worse. Setting the foreign exchange rate at 5,000 to the U.S. dollar would put it around 50 percent higher than the current rate. This would lead to a current account deficit, probably accompanied by a wholesale flight of capital. That would spell fresh catastrophe for Indonesia and deep danger for the region.
There is no comparison between present-day Indonesia and the conditions which prevailed in Hong Kong when the currency peg was introduced in 1983. Hong Kong had a flexible and transparent economy, and was precommitted to an autonomous currency board. Today, as well as huge reserves, it has the backing of China if conditions get tough.
Indonesia, on the other hand, faces a fiscal deficit of 5.5 percent of GDP. Cronyism flourishes. Social unrest and political uncertainty are growing. Foreign capital would not flood in to help sustain a peg. For this very sick economy, the only remedy is to take the medicine as prescribed, and to stop thinking that Indonesia is in any state to ape Hong Kong on the currency front.
-- South China Morning Post