Rupiah woes a lesson in crisis management

By P. Usmanto Njo and Marike Stellinga

JAKARTA (JP): Indonesia received an unwanted present for its 52nd anniversary. Like a tsunamic attack, the exchange value of the American dollar skyrocketed.

The rupiah exchange rate may be on its way back up but the damage is already done.

With the rupiah battered, Indonesia's rising star status has suddenly turned sour. Its long struggle against inflation now appears to be lost, just as the government became optimistic about achieving its 5 percent inflation target.

The prices of various commodities -- including wire, paper, sugar, electronics and cars -- are already creeping upwards. Like the rupiah, these prices may fall again but are unlikely to return to their "normal" levels.

Interest rates have become extremely high, at 30 percent to 40 percent for short term deposits, and are choking growth and decreasing company profitability. Exporters may gain in the short term, but should prices continue rising such gains will be swallowed by inflation.

Sadly, the volatility of the rupiah in the past few weeks also implicates the consequences of distribution and testifies to the vulnerability of the Indonesian monetary authority.

The return of the dollar's exchange value to its early August levels may well indicate some profit-taking exercises, rather than the attainment of a fundamental equilibrium.

As a result, repeat attacks against the rupiah remain a possibility and Bank Indonesia will likely keep the monetary situation tight for some time.

By selling dollars at high rates, speculators essentially proclaimed their triumph and reaped the reward of high rupiah returns. BI vowed to crush the "tail that wags the dog situation" when it announced the floating of the rupiah on Aug. 14, 1997. But in the end, it is the majority of Indonesians, despite being poor and financially unprotected, who must pay for the speculators profit.

What can be learned from the turmoil? We know that not even the wildest predictions could have cast a shadow on the past two weeks.

Indonesia's economic fundamentals are repeatedly said to be sound, displaying high growth, low inflation, a manageable current account deficit, sizable foreign reserves (including a standby facility), a balanced budget and prudent macroeconomic management. Why then was the rupiah under such massive strain?

The inherent volatility of globalized finance, what President Soeharto called "new realities", is a common explanation. With huge cross-border capital flows -- which reached a record US$ 244 billion for developing counties last year -- economies are increasingly vulnerable and dependent upon the rest of the world.

In this era of technology people are better and faster informed. But in hectic or uncertain times, when a lot of markets show large changes in prices, traders are increasingly afraid to draw an opposite conclusion to the market.

This brings us to the so-called "herd behavior". If everybody is running in one direction and you are not sure where to go, would not the best choice be to follow the rest? In such an environment a floating currency has the potential to overshoot its value. And stock markets can reach levels that are below their intrinsic value.

World Bank representative Dennis de Tray was recently quoted as saying that confusion and uncertainty had taken hold of regional financial markets as people adjusted to the workings of floating currency regimes.

In retrospect, there appeared to be too much optimism among domestic and overseas investors in Asia, in general, and in Indonesia, in particular. Local companies borrowed externally to finance increasingly ambitious projects, gambling with the assumed, long-term stability of the rupiah.

A report last month by PT Jardine Fleming Nusantara estimated that 50 percent to 60 percent of listed companies had total debts denominated in foreign currencies, particularly the U.S. dollar. This contributes to the picture of Indonesia as the third largest foreign borrower in the world.

As of June 1997, the ratio of Indonesia's total foreign debt to foreign reserves was about 500 percent, compared to 220 percent in Thailand.

A total of US$30 billion in company debts in Indonesia is believed to take the form of an unhedged dollar denominated debt. Ironically, the BIS (Bank for International Settlements) has been reportedly "wagging a finger at banks and investors around the world for what it sees as a growing appetite for risks".

Interestingly, in the 12-day period to Aug. 19, the Indonesian rupiah was virtually slipping against most other currencies, including the Singapore dollar and the Malaysian ringgit. BI's selling rates for American, Australian, Hong Kong dollars and the yen jumped by 15 percent to 16 percent, on average. The French franc, German mark and Dutch guilder appreciated by 18 percent to 19 percent during the period. The selling rates of the Singapore dollar and Malaysian ringgit increased by 12 percent and 9 percent respectively.

Indeed, after an initial, regionally-driven beating, the rupiah and the JSE were slugged again by internal pressure. Not only did firms buy dollars to hedge large, open dollar liabilities, but also ordinary Indonesians falsely sought to secure their meager savings by buying dollars.

So fragile was Indonesian confidence in the rupiah that the dollar remained a selling commodity here when overseas fund managers had already stopped dumping the rupiah. Of course, wild rumors, including the "death" of Finance Minister Mar'ie Muhammad while he was actually enjoying his afternoon jog, further embellished the situation.

The reading of these events is one of inherent restlessness within the Indonesian society. Undoubtedly, as manifested in the recent social riots, a "political overhang" remains and unresolved social discord points to the potential for future eruptions.

Controversial projects such as the national car, the Jakarta Tower and the N-2130 jet, have added fuel to the fire. Without substantial political reform, anticipation of eventual "trouble" will remain widespread. And, in this scenario, the rupiah -- the token of Indonesia's economic and political system -- will continue to be vulnerable to swings in popular mood.

Of course, globalization accommodates these sentiments. In a globalizing economy market, forces become more powerful and destructive if they are not harnessed properly. Policies that obstruct market dynamics will prove increasingly costly and inefficient.

Alas, while successive economic reforms have become the hallmark of Indonesia's impressive performance, the tide of deregulation seems to have surrendered in recent years to the persistence of vested interests in important industries.

At this stage, we could at least make a positive point. Indonesianist Hal Hill has pointed out that the nation is an effective crisis manager. That is, in bad times, Indonesia's eco nomic policy becomes more market oriented as the position of technocrats in the government becomes stronger.

The current rupiah crisis, at least, has reasserted the need for streamlining the Indonesian economy and revive the momentum of deregulation in the country.

P. Usmanto Njo is a Ph.D student from the Asia Research Center, Murdoch University, Western Australia. Marike Stellinga is an MA student from the Department of International Financial Economics at the University of Amsterdam, Holland.

Window A: What can be learned from the turmoil? We know that not even the wildest predictions could have cast a shadow on the past two weeks.

Window B: The current rupiah crisis, at least, has reasserted the need for streamlining the Indonesian economy and revive the momentum of deregulation in the country.