Rupiah strengthening

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.