Pegging the rupiah
The economic crisis facing the nation as a result of volatility and weakness in the rupiah exchange rate demonstrates how fundamental a stable currency is to a healthy and growing economy. Well known British economist John Maynard Keynes rightly observed in one of his essays as long ago as 1931 that, "there is no subtler, no surer means of overturning the existing basis of a society than to debauch its currency."
Unstable and upward spiraling prices which we are now facing create uncertainty, hamper business planning, inhibit long term investment, erode the purchasing power of salaried workers and discourage savings.
The persistent volatility of the rupiah at a very low rate of exchange against the U.S. dollar, despite the various reform measures already undertaken, is bound to lead the economy into a yet bigger crisis, with potentially devastating social consequences. In fact, alarms are already sounding. In recent weeks, sporadic riots have ripped through several towns in Java, Sulawesi and the eastern islands of Indonesia.
It is therefore understandable that the government has been looking for ways to rein in the currency and quickly bestow stability on the beleaguered economy. One such idea touted towards this end is a fixed rupiah exchange rate for basic necessities aimed at ensuring short term economic and social stability.
President Soeharto hinted on Monday, during a meeting with Moslem scholars, that he would shortly announce new policy initiatives designed to stabilize the rupiah exchange rate. He did not give details beyond saying that a fixed exchange rate was urgently needed for priority imports for the manufacturing industry and basic necessities.
As we understand it, the scheme aired by the President is a contingency program, aimed at fixing the rupiah exchange rate against the dollar for designated imports. The government achieves this by paying the difference between the fixed and prevailing market exchange rates. This will help import dependent industries continue production in a more orderly condition and will ensure adequate supplies of basic staples and medicines.
However, this scheme is not designed to create a sustainable exchange rate in the long run. It is a crash program to remedy the acute shortage of basic necessities and to enable manufacturing companies to continue operations, thereby preventing massive redundancy.
If implemented, this system will lead to a two tier exchange rate, with an artificially low, fixed rate for essential imports, most probably much lower than the current range of Rp 9,000- 10,000, and a floating market rate for all other transactions. This will place a huge, additional burden on the state budget, both to meet the exchange rate differences and to subsidize import prices at levels low enough to be affordable by the common people. But the immediate benefit is relative price stability and adequate supplies of basic necessities. A bigger challenge is perhaps on how to ensure that imports funded with subsidized foreign exchange are made really for most essential commodities.
In a related development, Bank Indonesia Governor Soedrajad Djiwandono told a hearing of the House of Representatives on Monday, and reaffirmed Tuesday, that the government was in the initial phase of evaluating a currency board system (CBS).
A CBS is a monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified (anchor) foreign currency at a fixed exchange rate. For example, a CBS could immediately undertake to fix the rupiah at an arbitrary rate of Rp 5,000 to the dollar. This would rescue many companies who are technically bankrupt, reduce the costs of imports and minimizing inflationary pressures.
However, rigorous evaluation of the currency board system (CBS) will take considerable time and current circumstances make sustaining a fixed exchange rate in any case, an unviable proposition.
Such a system would be an easy target for currency speculators and huge foreign exchange reserves are needed to defend the chosen rate of exchange. Furthermore, many of the other factors required to successfully run a currency board system, such as a sound banking system, low inflation and good governance, are not yet present. Political independence for the CBS must also be guaranteed.
Without these conditions, the system will lack the credibility upon which its ultimate success depends. Given our present condition, a CBS arrangement will only be viable, at the earliest, by the year 2000 when most of the reforms included in the three-year package agreed with the International Monetary Fund have been carried out.