Pegging the rupiah
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.