Return to the fixed rate system

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.