Rupiah in uncertain times
Bank Indonesia made the correct decision last week by not using any of the ammunition in its arsenal to shore up the rupiah, which dropped to a seven-month low of Rp 8,768 against the dollar on Friday morning before closing the week at Rp 8,380.
Dipping into its foreign reserves to support the rupiah would have squandered its small stock of hard currency to maintain a degree of confidence in the country's economy. The central bank's net international reserves of US$18.27 billion as of early May certainly would not be enough to fight speculators.
Raising interest rates might have aborted the nascent economic recovery and further increased the state budget deficit to an unmanageable level, because the costs of the almost Rp 310 trillion ($36.5 billion) in treasury bonds already issued to recapitalize the country's ailing banks would consequently increase sharply. Moreover a widely predicted monetary tightening in the U.S. would most likely nullify the impact of any rise in domestic interest rates.
That is because the market's negative sentiment on the rupiah has been fueled by a barrage of confusing remarks by senior government officials, political controversy over the Cabinet's economic team and uncertainty about the future of the reform measures that are sorely needed to stabilize and strengthen the foundations of the economy. Needless to say, the financial market is highly sensitive to (mis)information and rumors.
The market has been nervous since late last month, following the political controversy and questionable reasons behind the firing of two key economics ministers, one in charge of industry and trade, the other state enterprises and investment.
Market jitters increased early this month after the government and the International Monetary Fund failed to agree on a new set of reform measures for a new letter of intent. Despite the government's claim the delay was simply technical, analysts saw the further postponement of the signing of the letter of intent as proof of the government's inability to reach a rapport with the IMF. This followed the multilateral agency's decision to defer the second disbursement of its loans to the country from the original schedule of early April, because of its disillusionment with the slow pace of reform over the past three months.
Adding to the uncertainty was President Abdurrahman Wahid's appointment of two close aides to a special team in charge of monitoring the performance of the Cabinet's economic team, a function that was understood to be the responsibility of the National Economic Council.
This move, in addition to the President's decision early this month personally to lead weekly Cabinet sessions on economic matters, increased speculation that the job of chief economics minister Kwik Kian Gie, one of the few ministers in the Cabinet highly respected for his impeccable integrity and hard work, was on the line. Kwik's pessimistic comments last week about foreign investor confidence in the country, though accurately reflecting conditions, poured fuel on the rumors that Kwik was indeed frustrated with the internal hurdles he faced in managing the economy.
Market confidence in the country's economic management took another dive after mass media coverage of alleged corruption, collusion and nepotism among Abdurrahman's relatives and close associates, and the confirmation that Abdurrahman's younger brother Hasyim Wahid was assigned as a special adviser to the government's most powerful economic organization, the Indonesian Bank Restructuring Agency.
Even though the rupiah's recent plunge did not necessarily reflect, nor immediately cause, deteriorating economic fundamentals, a prolonged volatility would eventually abort the budding economic recovery.
But market intervention by the central bank would not be effective in stabilizing the rupiah. The best way to safeguard the currency is for the government to act firmly to restore market confidence in its economic policymaking and execution and in the consistency of the reforms it is and will pursue. A clear endorsement by the IMF of the country's new set of reform measures would greatly help accelerate the process of regaining market confidence.