Rupiah strengthening

Neither the recent mysterious killing spree in East Java, nor the latest wave of student demonstrations in the capital has been able to impede the rupiah's strong rebound that started last month. The local currency has surged steadily, except for an aberration on Thursday last week when it tumbled to 7,750 from 7,150, wiping out almost 10 percent of the spectacular gain it made until the previous day because of a wrong signal from the country's chief economics minister, Ginandjar Kartasasmita.

The rupiah returned to a more stable range immediately after Ginandjar clarified his remarks and, more encouragingly, it did not fall back below 8,000, the level reached in the second week of this month.

At first glance it might seem that the rupiah's steady appreciation since last month has been a natural phenomenon, the cumulative impact of the incremental progress the government has made in many of its reform programs and the stronger vote of confidence from the International Monetary Fund (IMF) and international sovereign donors. The recent robust appreciation of the yen against the dollar undoubtedly played its part but not a pivotal one because when the yen began to decline again early last week, the rupiah bucked the trend.

This is, in the main, very good news indeed because, as we have repeatedly stressed in this column, a stable and reasonable exchange rate is crucial to alleviating our economic woes. It is not an exaggeration to say that none of the reform measures are likely to be effective unless the currency recovers to a sustainable market level.

But it is highly debatable whether the pace of the rupiah's strengthening has been fully market-driven. Greatly encouraging as it may seem, we nonetheless have a sense of foreboding that the recent appreciation was too great and too fast. The monetary authorities and most analysts also agree that too fast a rise in the rupiah's exchange rate without any marked improvement in the economic fundamentals will only fuel more speculation as market players will consider it highly tenuous. Too high an appreciation is also hurtful to the export industry.

The pace of the appreciation seems to be highly speculative and consequently highly vulnerable because there have not been any dramatic decrease in the major economic, social and political risks that have so far weighed down on the rupiah.

Moreover, the rupiah rate development has taken place in a very thin market where a position of a few million dollars could have a great influence. The fact is the government has of late been converting millions of dollars daily out of the foreign aid it got under the bail-out program into rupiah to finance its cash-strapped budget and accelerate the safety net programs for impoverished people.

It is also difficult to take the rupiah's movement as entirely natural when imports have collapsed and domestic debtors have simply stopped paying foreign debts, thereby depressing the demand for dollars to an abnormally low level. Failure to settle the US$64 billion debt overhang, of which $22 billion is due before March, may see many debtors end up facing bankruptcy proceedings. This may suddenly fuel a big demand for the greenback and consequently push down the rupiah.

The massive bank restructuring program, which is scheduled to be completed later this year, is another soft spot for the rupiah rebound. Any delay or snafu in this crucial program will halt the rupiah's recovery because bank lending has virtually stopped since early this year.

Yet another big vulnerability is the democratization process -- a very complex issue given the economic crisis -- which will accelerate in a big way in the upcoming special session of the People's Assembly, to be followed by election campaigns possibly in March and April, the House election in May or June and the presidential election in December.

It is therefore much better and more sustainable to have a creeping, but steadily appreciating rupiah, to allow for a gradual lowering of the choking interest rates. Not a roller- coaster that makes it impossible to calculate risks. This condition therefore does not immediately allow any significant easing in the conservative fiscal and monetary policies, let alone a relaxation in the fully fledged implementation of the reform programs agreed with the IMF.