Monetary reform could pay divident

Monetary reform could pay divident

By Peter Duncan

JAKARTA (JP): Indonesia is about to embark on the most far-
reaching monetary reform of its half century of existence as an
independent nation. It is being discouraged from taking this step
by an impressive array of conventional banking and business
authority and wisdom from the IMF, the World Bank and national
leaders down through economists and analysts to the ever-
articulate brokers and fund managers.

This reform, the establishment of a Currency Board System
(CBS), will have the following benefits: First, it holds out the
prospect of basically sound businesses being able to meet their
debt payments. Second, it will eliminate Bank Indonesia's central
banking function of lender of last resort to government, other
banks, state enterprises, commodity boards, national business
projects, and well connected businesses. Third, it will leave two
rump components of Bank Indonesia -- one to deal with bank
supervision reporting and statistics, and the other to manage
whatever is left of BI's assets after it has handed over a clear
US$12-15 billion to the new Indonesian Monetary Authority. These
assets could become part of the assets of the Indonesian Bank
Rehabilitation Authority. All of these benefits are in line with
the intentions of the GOI/IMF agreement.

Doubters of the CBS should put their fears behind them and
back establishing a strong and orthodox CBS with the sole
functions of exchanging rupiah currency for U.S. dollars at a
fixed rate and managing the CBS reserves in conservative U.S.
dollar denominated securities.

The proposed Currency Board System (CBS), provided it is an
orthodox one, is a simple mechanism for converting the existing
and future Indonesian currency stock into greenback rupiah --
yes, U.S. dollars -- but just the currency, not the rest of M1
and M2. The question most troubling those who fear adoption of
the CBS is will it work? That is can it survive? They fear that
holders of rupiah (notes and coins) and claims on rupiah
(deposits) will decide that this is their last, best chance to
get real U.S. dollars at a good price, say Rp5,000 if that is the
agreed strike price. That is twice what a dollar cost in rupiah
less than six months ago but much less than the cost in rupiah
only a few weeks ago.

If there is such a flight to the U.S. dollar, rupiah currency
will soon command a premium. Notes will come from wherever they
are hiding and migrate to the CBS until there are few rupiah left
in the system for day to day business. We would then have to
conduct our daily business in greenbacks and barter or pay a
premium to get hold of rupiah currency.

But why should such flight occur? There are three main groups
of holders of rupiah and claims on rupiah. First, the business
elite, bankers, foreign debt holders, corporates and business
groups. Second, the business middle class, traders, owners of
small enterprises, operators of schools, households, and other
institutions. Third, the bewildered masses who receive a pittance
of salary or wages and spend most of it within days of receiving
it.

The first and second groups have done most of what they can
already to get out of rupiah and claims on rupiah, but they still
may lead another wave of flight from the rupiah. This would
contract the currency available and thereby tighten money supply
across the banking system. The third group has no choice but to
accept that what little cash savings they have are at least
halved in value and that they will have to live on maybe half or
less of what they have survived on before -- until such time as
the economy gets back to business as usual.

The government has two major problems of communication to
face. First, convincing the elite and middle business groups that
Rp5,000 to the U.S. dollars is fixed, come what may. Second,
convincing the bewildered masses that rioting, looting and shop
burning will only delay the process of recovery to real living
standards comparable with those of less than a year ago.

The only way to convince the elite and middle business groups
that the CBS will work and will be here to stay is to commit to
it irrevocably with ironclad safeguards.

Convincing the masses to suffer peacefully will not be such an
easy task. But surely that is what part of the US$39 billion of
the IMF Plus Package should be used for -- to ease the transition
from subsidized prices held in check in spite of much too rapid
growth in money supply (permitted by Bank Indonesia as a central
bank) to market determined prices in line with international
prices -- as well as to finance the recovery and back the debt
repayment of banks and corporates.

Why are the IMF, WB and other interested parties not backing
this necessary and tough decision? Perhaps because they fear the
loss of power, authority and prestige that comes with pulling
down the walls of the temple of central banking. Or because they
fear the contagion effect of giving up sovereignty over monetary
management to the U.S. Federal Reserve Board.

Or because they are worried that a fixed link to the U.S.
dollar will tie the rupiah to shifts in the U.S. dollar against
the currencies of other countries, most notably Japan and China,
and thereby distort development of trade and investment with
these countries. Surely, the prospect of a fixed exchange rate
for the rupiah instead of the present chaos should outweigh these
concerns.

The writer is chief economist of the Castle Group.