Pegged rupiah draws mixed reviews

Pegged rupiah draws mixed reviews

By Roberto Coloma

SINGAPORE (AFP): A radical proposal to institute a peg for the Indonesian rupiah drew mixed reviews from dealers and economists yesterday, but market players took no chances and dumped U.S. dollars for regional currencies.

Indonesian President Soeharto, vowing to "kill" speculators attacking his country's currency, dropped hints Monday that he was looking at a Hong Kong-style peg, and market talk put the rate at 5,000-6,000 rupiah per dollar.

"I think they're going to do it, judging from all the evidence," said Daniel Lian, head of Asian markets research at ANZ Investment Bank in Singapore.

A senior official of the International Monetary Fund (IMF), which has spearheaded a near 40-billion-dollar bailout for Indonesia, reacted guardedly.

Kunio Saito, director of the IMF's Asia-Pacific regional office, said: "I think it is an interesting proposal worth exploring, but it is important to explore all the pros and cons before finalizing the policy."

"The most important thing at the moment is to stabilize the market and make sure that the markets remain stable. I think the option of this currency peg or currency board can be explored but the first thing is stabilization," he said.

The rupiah was hovering in late afternoon trade around 7,850 to the dollar -- up from 9,600 on Monday -- and boosted other Southeast Asian currencies as funds unloaded the dollar on news that a rupiah peg may be imminent.

Speculation that a peg akin to the currency board system which has shielded the Hong Kong dollar since 1983 was fueled last week when a leading proponent of the scheme, U.S. economist Steve Hanke, briefed Soeharto and his advisers.

Under a Hong Kong-style currency board system, every rupiah banknote issued would be backed by its equivalent in U.S. dollar reserves, and interest rates are used to soak back the local currency whenever the peg is tested.

P. K. Basu, head of macroeconomic research at Union Bank of Switzerland in Singapore, said Indonesia just might be able to pull off a peg of 5,000 rupiah to the dollar.

"But in order to sustain the credibility of that new peg and to ensure its long-term viability, it is going to be very important for Indonesia to cut inflation to very close to three percent or below, preferably to below the U.S. inflation rate," he said.

Interest rates would have to be pushed up to "prohibitive" rates initially to tame inflation, Basu said.

"That is of course a painful thing but the consequences of not doing it are worse because then, the credibility of the peg would immediately come under pressure and eventually interest rates would rise in any case," he said.

He said Jakarta was left with few alternatives apart from the peg.

"At 9,500 rupiah per dollar (Monday's level), most corporates cannot service their external debts. Virtually the entire private sector is largely bankrupt, and there is no new credit coming into Indonesia, so at these sorts of levels Indonesia does not have a functioning financial system," he added. But a currency dealer with a European bank did not buy the peg idea.

"I don't think it's possible to peg the currency at 5,000," he said. "I think at 5,000 the foreign reserves will be depleted very fast, but the market is of course cautious, so there is some selling of long dollar positions."

"If you look at this crisis, precisely what happened was that the Thai baht was pegged to a basket of currencies," he said. "It shows that artificial fixing of currencies does not work. It's funny that they are going back to it."

Currency turmoil began in July 1997 when Thailand freed the baht to market forces after a futile and costly attempt to defend it, forcing the Philippine peso and Indonesian rupiah to follow suit. The non-pegged Malaysian ringgit and Singapore dollar also succumbed, and the contagion spread to South Korea.

A Singapore economist was also skeptical about the viability of a peg and feared that politics may push Soeharto, who is expected to begin a seventh five-year term next month, to set a peg.

"We wonder where the money is going to come from to back it," said the economist. "People are looking at a full recovery of the region only when there are no more pegs. Politics-wise, I think he (Soeharto) is getting desperate."

"But because he has put his reputation on the line, he's saying I will make it happen," she added, referring to Soeharto's decision to personally oversee the implementation of reforms pledged to the IMF.