Return to the fixed rate system

While the government delays adopting a currency board system (CBS), economist Kwik Kian Gie proposes a simpler measure to overcome the country's monetary crisis.

Question: The rupiah's value remains low, threatening the survival of the economy, but several parties doubt the feasibility of a CBS for Indonesia. Do you have an alternative solution to the monetary crisis?

Kwik: Instead of adopting the CBS, which will surely crush the banking sector, we can reintroduce the fixed exchange rate system that we had used for 25 years. The government can set the conversion rate at Rp 5,000 to the dollar -- a level regarded as justifiable by the government, the International Monetary Fund (IMF), the World Bank and the Asian Development Bank.

At that conversion rate, the government can sell dollars without any restrictions or limitations. There will surely be a rush on dollars, but we can estimate the extent of this.

Suppose people convert 50 percent of the Rp 300 trillion money supply into dollars. The government will have to release US$30 billion in foreign exchange. Because the government commands foreign exchange reserves of about $17 billion, standby loans worth $2 billion and foreign assets of $5 billion, it needs a further $6 billion to cope with the rush.

To cover the balance and to guarantee the availability of foreign exchange for imports, the government can ask the International Monetary Fund to disburse $20 billion of its committed loans. Alternatively, it can seek loans from countries such as Singapore, China (including Hong Kong), Brunei, Taiwan, Japan and Australia. Indonesia will avoid having to adopt a CBS, and its relations with the IMF will improve.

Q: What is the difference between the old peg system and a CBS?

K: With a currency board, the government only has to provide $4.8 billion -- far less than the reserves of $17 billion -- to anchor the money in circulation, which is currently estimated at Rp 24 trillion, if the rupiah is fixed at Rp 5,000 to the dollar.

The low conversion rate would encourage depositors to withdraw and convert savings -- up to Rp 150 trillion -- into dollars. This massive demand for money could cause liquidity problems in banks. Under a CBS, the central bank, is not allowed to provide liquidity assistance to the banks, even temporarily.

Under the old fixed exchange rate system, Bank Indonesia has the right to manage and control the money supply and to provide liquidity assistance to commercial banks. With a loan of $20 billion, the central bank can cope with the demand for dollars.

If the rupiah can be maintained at Rp 5,000 to the dollar for just one month, confidence will be restored and many dollars will be reconverted into rupiah. Banks can attract rupiah deposits by offering higher interest rates than for dollar savings accounts.

When the monetary condition stabilizes and a lot of dollars return to the country, we can repay the IMF loan.

Q: Can a fixed exchange rate system be implemented when corporate foreign debts have not been rolled over?

K: Private sector debt is irrelevant because demands for debt repayment will not increase the money supply.

Q: How can a fixed rate system be implemented if about 70 percent of the country's 212 banks are facing liquidity problems?

K: The number of insolvent banks will increase but as soon as dollars are reconverted into rupiah after the restoration of public confidence, bank liquidity will improve, provided they offer attractive interest rates.

Q: Can a fixed rate system be implemented without the confidence of foreign investors?

K: The system is a crash program to overcome the monetary crisis. To restore foreign investor confidence, we need to eradicate corruption and improve efficiency and competitiveness.

Q: You said we can ask the IMF to disburse $20 billion of its committed aid. Will the IMF, which usually disburses its aid on a quarterly basis, change its procedures for Indonesia?

K: That depends on whether or not the IMF grasp that Indonesia's economy will collapse in four to six months if the rupiah continues to hover around current exchange rates.

The IMF's reform package is good but it evidently cannot help restrain the rupiah's fall against the dollar because it is not designed as an emergency measure to solve the monetary crisis.

Q: The government claims to have implemented the IMF's reform package, including abolishing cartel-like marketing organizations. However, the Indonesian Wood Panel Association has mimicked past cartel practices...

K: The IMF must act strictly toward Indonesia and force the government to implement reforms, or terminate the agreement and the $43 billion aid package.