Problem with monetary evangelicals

Problem with monetary evangelicals

By Bondan Winarno

JAKARTA (JP): Indonesians did not like what they saw on
television. President Soeharto signing an agreement with the
International Monetary Fund (IMF), as its director, Michel
Camdessus, looked sternly on with crossed arms.

Former Jakarta governor turned dissident, Ali Sadikin, said
"Soeharto is bad all right, but he is my president. Camdessus was
treating my president like he was his colonial master."

Then came Steve Hanke peddling the virtues of a currency board
system (CBS) to the government of Indonesia. He took center stage
at President Soeharto's residence, where Camdessus had been just
a few days before, when he briefed Soeharto on the wonderful
world of currency boards. "A CBS is the only way to end
Indonesia's crisis", Hanke later remarked to the press.

Smooth talking, wearing academic looking spectacles, he later
gave a lecture on currency boards to a hoard of Jakarta
journalists, with convincing credibility. Momentarily, the
journalists forgot that Hanke moonlights as a currency trader.

Indeed, Hanke did not even correct Jakarta newspapers which
hailing him as the "father of CBS", when in fact it is a concept
dating back to the British Empire. The first currency board was
established in Mauritius in 1849 and the system reached its peak
in the late 1940s.

Currency boards were abandoned in favor of central banks as
colonial empires receded. However, when central banks became
susceptible to government pressure to finance excessive deficits,
currency boards were revived. Approximately seventy countries
now subscribe to CBS in its modern form.

Hanke wrote his first book on currency boards with Kurt
Schuler in 1991. Milton Friedman is among contemporary economists
who view CBS as a possible monetary system for Eastern Europe and
the Third World. Many even believe that fixed exchange rates
might become the way of the future.

To me, Hanke sounds like an apocalyptic preacher. He came
promising heaven to those who for too long have been staring at
the gate to hell. Choose CBS now, lest Armageddon come in four
months.

To worsen the appearance of hell, Hanke forecast inflation
running at 1000 percent this year, but he did not substantiate
this claim.

Peter F. Gontha, a business associate of one of President
Soeharto's sons, quickly denied any role in arranging the meeting
between Hanke and President Soeharto. People now believe that it
was Mohamad (Bob) Hasan, a timber tycoon closely linked to
Soeharto, who rang Hanke when the latter was on holiday in
Istanbul.

Hasan has a reputation for this sort of covert operation.
Whatever the truth, Hanke won Soeharto's ear. Hanke believes a
currency board can do no wrong. "There has been no history of a
bad currency board system anywhere in this whole world", he said
during an interview with TVRI, the government-owned television
station.

In the same interview, Hanke strongly stated that there is no
technical conflict between CBS and the IMF. "A CBS... complements
the IMF package," he said.

However, moments later he said that the "IMF sets
preconditions for Indonesia to achieve stability... But, the
rupiah will collapse before stability is attained", in blatant
contradiction to his earlier statement.

In the interview, Hanke also questioned why conditionality
attached to an IMF loan to Bulgaria required the recipient
country to adopt a currency board, while the IMF strongly opposed
a currency board in Indonesia. Perhaps Hanke was correct to make
this reference, but it is nevertheless misleading.

In an article in Kontan, Jakarta's weekly economic newspaper,
Prof. Emil Salim pointed out that Bulgaria is a case apart from
Indonesia. When a currency board was introduced in Bulgaria, the
banking system was in good order. "We can have a CBS in
Indonesia, but with the banking system in its present state, we
will all sink," Salim said.

That a CBS does not contradict IMF reforms is not quite
accurate. In fact, the IMF just reaffirmed that it will cancel
the aid package if Indonesia introduces a currency board. The G-7
meeting in London also called on Indonesia to delay a CBS.

Behind the dogmatism, Hanke's logic, when discussing CBS, must
be treated with care. He stated that with CBS "interest rates
would fall because of increased credibility". There are two flaws
in that statement.

There is no evidence to suggest that interest rates fall in
response to improved credibility. Furthermore, there is the
matter of credibility itself. Hypothetically, a currency board
will improve credibility, but if the government hold insufficient
currency reserves to manage a currency board, then credibility
would quickly disintegrate.

Hanke's rhetoric makes it sound like no brain is required to
run the system. "It is very restrictive and disciplined. It runs
on an automatic mechanism," he said. So can one fall asleep at
the wheel?

A currency board will, according to supporters, give Indonesia
a credible mechanism with which to defend a fixed exchange rate.
The cost will be loss of control over monetary policy. There is
also confusion over the specifics of the proposed system.

Many people fail to distinguish between a fixed exchange rate
and a pegged exchange rate, which are different entities. Holding
the exchange rate constant is the top priority in a fixed
exchange rate regime. Under a pegged system, other policy tools
such as the interest rate are also considered and the term 'peg'
alludes to a certain mobility in exchange rates -- a fixed but
adjustable exchange rate system.

The currency board system being touted for Indonesia is
definitely a fixed exchange rate regime with very restrictive
rules. But a fixed exchange rate can be achieved without a
currency board. Indonesia has used a fixed exchange rate regime
for two decades without a currency board.

A currency board can also come under different guises.
Singapore's Board of Commissioners of Currency is a currency
board which does not fix the exchange rate -- Singapore uses a
managed float regime.

For Indonesia, the question is whether to fix or to peg the
rupiah. A return to a free floating currency is almost certainly
out of the question.

Popular argument has recently favored fixing the rupiah to a
dollar rate of exchange conducive to production and trading. This
would be complemented by limiting the use of foreign currency to
those with legitimate business needs to do so.

Informed people in Indonesia now believe that Soeharto is
reconsidering his plan to introduce a currency board, but amid
all the speculation, one question still remains unanswered. Will
an Indonesian currency board lead to the demise of Bank
Indonesia?

In Singapore, the central bank coexists with the Board of
Commissioners of Currency. One institution does not make the
other obsolete.

In Hong Kong, the Exchange Fund (currency board) was
introduced in 1985 after serious speculative attacks on the Hong
Kong dollar. The exchange fund cooperated with the Banking
Commission, which had a mandate to supervise banking and
financial institutions in the territory, until 1993, when the two
were merged to form the Hong Kong Monetary Authority (HKMA). The
HKMA is technically a central bank which performs extra currency
board functions.

There is no need to dissolve Bank Indonesia if it is capable
of taking on the extra functions required to run a currency
board. In fact, if Indonesia opts for a fixed exchange rate
regime without a currency board, the role of the central bank
will be vital.

CBS, just like any other monetary system, has advantages and
disadvantages. Suitability depends on a country's fundamentals. A
currency board may be appropriate for Indonesia, but for this to
be true, certain prerequisites for success must be met. That all
these prerequisites are present in Indonesian society is
debatable. Furthermore, since Hanke is not the sole authority on
currency boards, Indonesia should take the time to listen to
other supporters and opponents of this controversial exchange
rate regime.

The writer is a business consultant based in Jakarta.

Window A: Popular argument has recently favored fixing the rupiah
to a dollar rate of exchange conducive to production and trading.
This would be complemented by limiting the use of foreign currency
to those with legitimate business needs to do so.

Window B: Informed people in Indonesia now believe that Soeharto
is reconsidering his plan to introduce a currency board, but amid
all the speculation, one question still remains unanswered. Will
an Indonesian currency board lead to the demise of Bank
Indonesia?