Let speculators panic

Bank Indonesia should not budge on its move last week to slash the supply of rupiah that can be used for speculation overseas despite noisy protests and complaints from banks in Singapore, where the bulk of offshore rupiah trading is done.

The rules that severely limit rupiah transactions between onshore banks and offshore parties will obviously have a big impact on how the Indonesian currency is traded in Singapore.

Many Singapore-based banks may have to begin soon unwinding their rupiah positions, and as the rupiah trade offshore dries up, many speculators will likely move their deposits back onshore. Banks may also decide to change their rupiah into dollars, thereby further pressuring down the rupiah. But this impact will only be temporary.

Most important is that offshore trade in rupiah will dwindle to a trickle or even die because banks will not be able to get fresh supplies of rupiah, and with the interbank market so short of liquidity, not many offshore speculators will be willing to take speculative positions against the rupiah.

True, as most analysts have persistently argued, the main reasons for the rupiah's weakening and its volatility are the political uncertainty, heavy foreign debt servicing by local corporate debtors and Indonesian exporters' preference to keep the bulk of their earnings overseas. But these factors are not completely new, having been looming over the economy for the past two years.

These risks should have been factored in by the market and should have been reflected in the rupiah rate at least since mid- 2000, when political pressures against President Abdurrahman Wahid began to escalate. If it had only these factors, the rupiah rate should not have fluctuating so wildly. As Bank Indonesia has found from its close monitoring of the foreign exchange market, speculators also have been largely responsible for the wild volatility.

Moreover, rupiah trading overseas does not benefit the Indonesian economy at all. It, instead, only adds to pressure on the rupiah. Speculators who use the rupiah simply as a trading commodity have made the local unit highly vulnerable to rumors, however wild they may be, and have put the rupiah rate mostly way below the level of what is considered commensurate with the economic fundamentals.

Of most importance is that the new rules do not slap any impediment on Indonesians and foreigners with trade and investment deals in Indonesia. And the central bank does still firmly uphold the fundamental principle of free capital account in the sense that spot onshore transactions and those with underlying trade and investment deals remain fully free, and Jakarta-based foreign banks are treated as residents.

Moreover, Bank Indonesia has said that maturing foreign exchange transactions agreed to before the new rules took effect must be honored.

The impact would have been more chaotic, had the central bank taken the option of making it compulsory for Indonesian exporters to repatriate their earnings in a bid to increase the country's foreign exchange reserves. Given the inadequate administrative capacity to administer such a rule, that policy would only deteriorate into a new source of corruption and collusion.

Several Latin American countries which had tried this measure found themselves with more complex problems as exporters tried to circumvent the measure by underinvoicing their export prices, thereby enabling them to keep most of their earnings overseas. The governments had to hire international surveyor companies to make preshipment inspections of exports to check their actual market prices.

It should be realized, however, that the new rules will not altogether stop speculation on the rupiah, nor will they be fully effective in preventing the rupiah from further weakening in so far as the risk factors that have been looming over the economy are not reduced. Nonetheless, the slash of rupiah supply to speculators overseas will, at least, neutralize one source of pressure on the rupiah.