Rupiah in uncertain times

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.