Political reform may boost rupiah

The disbursement of aid from the International Monetary Fund (IMF) has failed to boost the rupiah's value against the U.S. dollar. Pande Radja Silalahi, head of the Centre for Strategic and International Studies' (CSIS) economic department, discusses the causes of the failure.

Question: Why has the rupiah weakened despite the IMF's US$1 billion disbursement approval of additional aid?

Pande: The government's decision Monday to hike fuel prices and electricity tariffs which drove other prices up and sparked rioting in various towns has eliminated any impact the aid might have had in propping up the rupiah.

Market players were about to react positively toward the long- awaited disbursement of the IMF aid, which will open the door to the release of more than $6 billion in aid from other parties. But their reaction became negative after the government announced the fuel and electricity price increases, which could contribute up to 10 percentage points to this year's inflation rate and, in turn, weaken the rupiah.

Furthermore, rioting and the escalation of student demonstrations as well as the negative reaction of the House of Representatives toward the fuel and electricity price hikes have also increased political tension. The political factor currently contributes 70 percent toward determining the rupiah's value. Economic fundamentals now contribute only about 30 percent to foreign exchange developments.

Bank Indonesia's recent injection of Rp 103 trillion ($12.8 billion) in liquidity loans to unhealthy banks has also put downward pressure on the rupiah's exchange rate.

Q: Do you think that the recent disappearances of political activists and other human rights violations will affect the rupiah's exchange rate?

P: I'm afraid so. Associations of importers and consumers in the United States and European countries, influenced by human rights- related organizations in their nations, might boycott imports from Indonesia and threaten banks supporting imports of Indonesian goods into their countries. If that happened, Indonesia's foreign exchange revenue would be affected and the rupiah's value would come under further pressure.

Q: Do you think the rupiah could slide further, down to say Rp 10,000 to the dollar?

P: Sure. If the political tension intensifies and the government loses confidence (in what it's doing), the dollar could easily surge in response to the public rush for dollars as the majority of the rupiah supply is now being saved outside the banking sector. The offering of more than 50-percent interest rates has failed to attract depositors to return their funds to domestic banks.

Q: Will the fall of the stock market affect the rupiah's value?

P: Share price declines might pressure the rupiah's value downward if investors sold their shares to raise funds to buy dollars.

Q: Is it necessary for the central bank to raise interest rates on its promissory notes, SBIs, to defend the rupiah?

P: Increasing interest rates will be meaningless. The fact that the recent increase in rates by five percentage points failed to prop up the rupiah proved that restoring confidence is more important than using the central bank's money market instrument.

Q: Do you expect foreign investors to return soon to Indonesia?

P: I think foreign investors are unlikely to return to Indonesia before the government launches political reform as demanded by demonstrating university students and other members of society. They believe that without meeting the demands for political reform the political situation will deteriorate further.

The government, therefore, should launch political reform quickly. Failure to do so will cause foreign investors to invest in other countries and therefore we will have to wait for a long time, at least three years, to attract their investment back to Indonesia.

Q: From your observation of Indonesia's economic fundamentals in the past few months, what do you think is the equilibrium level of the rupiah's value against the dollar?

P: I think the sound equilibrium of the rupiah's value is now less than Rp 6,000 to the dollar. But achieving that level will very much depend on political development in the country.

The government should take a cautious response to political developments because rioting in Medan, North Sumatra, indicates that people's tolerance of the current economic difficulties has reached its limit.

Q: Do you expect the rupiah to strengthen if Indonesian debtors reach a substantive agreement with their foreign creditors in their meeting next week in Tokyo?

P: If the creditors agree to roll over their loans to Indonesian debtors for three or four years, that will help. But how far such an agreement will boost the rupiah will depend on political developments. (riz)