Skepticism looms over RI's CBS plan

Skepticism looms over RI's CBS plan

HONG KONG (Reuters): Asian fund managers have expressed a high
degree of skepticism over proposals by Indonesia to introduce a
currency board mechanism.

They said Indonesia needed confidence rather than a new
monetary system to shore up the rupiah, which Friday was closed
at 8,000 to the U.S. dollar after hitting a record low of 17,000
last month.

"Re-establishing confidence is of critical importance," said
Marshall Mays, chief strategist at Nikko Securities.

Tough action to clean up rotten banks, proof that nepotism and
corruption were things of the past and concrete steps to solve
Indonesia's huge private sector debt problem were the only
possible routes to a return in confidence, fund managers said.

"The real issue in Indonesia is how do we really progress,
move forward on these issues, and I don't think they can be
solved just by a different exchange rate mechanism," said Eugene
Chung, chief Asian investment strategist at SBC Warburg.

Politics remained the key, the strategists said.

President Soeharto appears to be backing a currency board as a
quicker method of raising the value of the rupiah currency in a
bid to bring down prices and help resolve the debt issue.

Some critics say vested interests in Indonesia see a pegged
rupiah as a way of protecting their assets.

"It's hugely popular with the crowd in charge right now
because they have a hope they can hold onto their goodies, where
if they have to give up monopolies, do the right thing and
restructure the system, they would suffer," said Mays.

A currency board would fix the rupiah to an external currency
such as the U.S. dollar or Japanese yen, with full cash-backing
for the amount of rupiah in circulation.

In theory, the Indonesian central bank would then forfeit
control over monetary policy to the United States or Japan,
implying lower rates along with a stable rupiah.

In practice, Asia's experience with fixed exchange rates has
demonstrated investors' insistence on country risk premiums over
and above the rates applied to the external currency.

"In Hong Kong, we know from experience that interest rates are
a function of the risk premium," said Chung.

Those premiums made a substantial contribution to the Asian
crisis. Huge and volatile U.S. dollar inflows seeking high
interest and no currency risk ramped inflation throughout Asia,
swelling credit and building unsustainable asset price bubbles.

Those asset bubbles collapsed like dominoes after Thailand
devalued the baht last July 2, sparking rapid capital flight.

If Indonesia fixes its currency again, those inflows could
return and repeat a process clearly identified as dangerous.

"The risk that people will borrow U.S. dollars again, assuming
its guaranteed, is not inconsiderable," said Mays.

Foreign investors were also skeptical of Indonesia's political
will to allow the currency board to work independently -- and
independence would be key to its successful operation.

"We're not even sure we have that political will here in Hong
Kong," said Chung. "In theory, things can work out beautifully
but in practice, politics does matter unfortunately. Politics is
everything in Asia."

Hong Kong has faced criticism for acting to ease the interest
rate burden during speculative attacks on the Hong Kong dollar,
pegged at a rate of HK$7.80 to the U.S. dollar.

Although most commentators supported the Hong Kong
intervention, others argued the currency board should be allowed
to work in total isolation from interference, with rates moving
only according to market demand for the domestic currency.

The fear among foreign investors is that Indonesia will refuse
to abide by the currency board when rates shoot high enough to
damage corporate activity.

Instead of allowing higher rates to force economic adjustment
-- bankruptcies or bank failures -- Indonesia could instead
resort to printing money to maintain the status quo, the fund
managers said.