Rupiah floatation 'worsens the crisis'

JAKARTA (JP): Former Bank Indonesia (BI) governor J. Soedradjad Djiwandono admitted yesterday that the central bank's decision to free float the rupiah last August led to a deeper economic crisis than the authorities predicted.

He explained that the rupiah's flotation and the monetary tightening that followed failed to curb the fall in the rupiah, and instead caused the banking sector to start suffering and some banks even experienced runs by depositors.

"After some time the real sector started to feel the impact since banks reduced lending and lending rates rose dramatically," he said in a statement titled: The rupiah -- one year after the float, delivered at a luncheon organized by the Indonesia- Australia Business Council.

The currency shocks that began in July led to banking sector distress and finally resulted in what has been a total year-long economic crisis.

Soedradjad said that the central bank's initial responses to the rupiah crisis failed to work because confidence was evaporating in the region.

"Confidence is very difficult to describe. We only know how crucial it is when we do not have it. When confidence is present the market is not very demanding. However when it is lost, everything we do is not good enough," he told foreign and local businessmen, including IABC president Sabam Siagian.

He pointed out that according to the Institute of International Finance, capital outflows in 1997 from crisis-hit countries including Indonesia, Thailand, and South Korea totaled US$12 billion, compared to $93 billion in capital inflow in 1996.

The foreign market players decided to shift their investment from the region after observing weaknesses in its economic structures -- the result of crony capitalism and the prevalent weak financial system, he explained.

"A completely different reaction came from the market (on BI's moves)," he said.

Soedradjad was BI governor when the rupiah crisis started in July 1997, and was fired by ex-president Soeharto in February, two weeks before the end of his term of office.

The market's negative reaction started prior to the August 14 rupiah flotation when BI widened the rupiah intervention band from 8 percent to 12 percent in an effort to ease pressure on the rupiah resulting from the contagion effect from the devaluation of the Thai baht.

Every time the central bank intervention bands were widened (five times between 1994 and 1997) an appreciation of the rupiah usually followed, he explained.

"But the last band widening instead caused the rupiah to rapidly depreciate," he said, adding that due to the failure of the managed floating system BI embarked on the free floating system.

He also said that the closing down of 16 banks in November was initially welcomed by foreign market players as reflected in the strengthening of the rupiah from Rp 3,900 to Rp 3,200 to the U.S. dollar.

"But it lasted only for 10 days because the foreigners also started to have doubts after the domestic market gave a negative reaction to the bank liquidations," Soedradjad said, adding that the bank liquidations eventually resulted in the collapse of the banking sector.

"Theoretically closing down insolvent banks should stop the bleeding in the sector, but we got a lesson that you should not close down banks when confidence is fragile," he said.

The government last week announced four of the six troubled banks under the Indonesian Bank Restructuring Agency (IBRA) were insolvent. Some analysts have urged the government to immediately liquidate the banks to restore confidence in the sector.

Soedradjad urged the administration of President B.J. Habibie to restore market confidence to enable its crisis-handling programs to work.

He said that the confidence was essential to create a positive perception, which had not emerged yet, to stimulate a positive response from the market.

"When confidence is lost we can't do anything. But when confidence is there we can do wonders," he said.

He explained that although habibie had made some progress in addressing pressing problems, the market was still adopting a wait-and-see attitude and refused to act positively.

"The turnaround has to be produced by the government by showing the market how it must view the whole problems and that there is a credible program been implemented," he said.

"The most important thing is to change the wait-and-see attitude to become positive. After that, with consistent implementation of the program, plus hopefully a touch of luck, the long path toward a recovery can be assured," he said. (rei)