Rupiah will be pegged to fixed exchange rate

JAKARTA (JP): Indonesia will soon establish a currency board system (CBS) to stabilize the shattered rupiah and is now finalizing legal and institutional frameworks to operate the fixed peg arrangement, Finance Minister Mar'ie Muhammad confirmed yesterday.

"The primary objective of the system is to restore public confidence in the rupiah and the banking system," Mar'ie said at a meeting with the House of Representatives.

The CBS is a monetary regime based on an explicit legislative commitment to peg the domestic currency to a foreign currency at a fixed exchange rate. Under this system, the domestic currency (usually base money) in circulation is fully matched by foreign exchange reserves.

"The government will strictly control the growth of the money supply to curb inflation and restore an orderly and stable economic condition," Mar'ie said.

Currency board arrangements, he said, could restore economic stability which could in turn gradually push down bank interest rates to reinvigorate economic activities.

Vice Speaker Abdul Gafur said the House fully supported the plan as it could quickly restore currency stability.

Gafur, however, explained that the government could submit the legal framework for the CBS operations to the House as a draft government regulation rather than through draft legislation.

President Soeharto has never publicly mentioned setting up a CBS to stabilize the rupiah, but he disclosed at a meeting with Moslem scholars Monday that he would soon announce new bold steps for the foreign exchange system to "kill" speculators.

He did, however, mention the need for a fixed exchange rate system to restore economic order.

The rupiah surged to 7,400 against the U.S. dollar Tuesday from Monday's close of 9,600 following reports on the plan to implement a CBS. The rupiah remained stable at 7,200 yesterday.

Mar'ie did not give any details on how the board would operate, including the timetable or which currency would be chosen to anchor the rupiah.

But his statement was the first official confirmation of rumors that the government was preparing to set up a CBS to stabilize the rupiah.

Soeharto reportedly took a close look at the system after he was briefed here by American economist Steve Hanke last week.

Bank Indonesia Governor Soedradjad Djiwandono said after a meeting with Soeharto on Monday that the President's Economic and Monetary Resilience Council was still studying the advantages and disadvantages of the CBS.

Steve Hanke

Speaking from his office in Baltimore, Maryland, Steve Hanke said Tuesday he was finalizing the plans for the CBS which could be up and running in Jakarta in less than three weeks.

Hanke, an American professor who was appointed special adviser to a top Indonesian economic policy council, said he would return to Jakarta this week at Soeharto's request to finalize details of the fixed exchange rate system.

"I'm returning to Indonesia and will be going through the final scrub-down and my own due diligence," he was quoted by Reuters as saying. "It clearly can be done in three weeks. We've done it before and in Indonesia it technically can be done in less time than that."

Officials with the International Monetary Fund and the World Bank said they needed more time to review the plan. The Clinton administration had no immediate comment.

"We're open minded," said chief World Bank spokesman Mark Malloch Brown. "It's not within the World Bank's competence to comment on immediate short-term exchange rate issues. That's for the IMF."

"Our point is we must look seriously at it, and obviously there will be a presumption that if the markets take it positively and it enjoys the authority of the Indonesian government it can contribute to achieving stability, a goal we all want," he added.

Malloch Brown said the bank was backing away from its earlier comments, which were highly critical of the proposal to peg Indonesia's battered rupiah to a fixed exchange rate.

An IMF spokesman in Washington declined to comment on the currency board proposal, but a fund official in Singapore appeared to cautiously welcome the concept.

"I think it's an interesting proposal and worth exploring," said IMF director Kunio Saito. "But it's important to explore all the pros and cons before finalizing the policy."

Rp 5,000 per dollar

Hanke said his rough calculations would place the rupiah peg at about 5,000 to the U.S. dollar, but this figure would depend on additional information from the Indonesian central bank.

Analysts are divided on whether it would be a smart move for Indonesia.

P.K. Basu, director of regional macroeconomics at the Union Bank of Switzerland, said a currency board should help the country recover economically.

Others say a CBS would not be appropriate for Indonesia, even though it had worked in Hong Kong, Argentina, Estonia, Bosnia and Bulgaria.

A currency board effectively replaces the central bank system, a move that would go against the agreement signed by Soeharto on Jan. 15 with the IMF to give more autonomy to the central bank.

Hanke said he believed Soeharto was serious about adopting a currency board.

The American economist has advised Argentina, Estonia and most recently Bulgaria on implementing currency boards.

The architect of the Hong Kong dollar peg, John Greenwood, said yesterday that a currency board system for Indonesia would be feasible but difficult to put into practice.

Greenwood, chairman and chief economist at LGT Asset Management, said in Hong Kong there was a risk the currency board idea was only being used as a political weapon as Indonesia faced an election overshadowed by the financial meltdown.

"There is a risk that it is something being used as a political weapon to deal with a political problem, namely the election," he said.

Greenwood said a currency board required "a highly flexible economy and a political system that is preconditioned to allow the currency board system to remain active."

Indonesia would additionally need to address problems regarding the solvency of the banking system. "It is difficult to envision a currency board system where the payments system is not operating satisfactorily," he said. (08/vin)