Stable rupiah needed for recovery

Stable rupiah needed for recovery

The rupiah remains very weak, even after the central bank
significantly increased its promissory note rates last week.
Economist Kwik Kian Gie discusses the necessity to stabilize the
country's foreign exchange system.

JAKARTA (JP): The press has devoted pages to efforts to
overcome the economic crisis but no substantial breakthrough has
been made yet.

President Soeharto, in his accountability speech before the
People's Consultative Assembly on March 1, for example, invited
the International Monetary Fund (IMF) and foreign heads of
government to help formulate measures that would lower the U.S.
dollar's value against the rupiah and keep it stable at a proper
level. Such measures would be implemented on top of the reforms
sponsored by the IMF; the combination of the measures and the
reform Soeharto called IMF-plus.

The President then said he was considering very carefully
whether to implement a currency board system (CBS). However, IMF
managing director Michel Camdessus said a few days ago that the
Indonesian government had decided not to adopt the CBS. The
government did not deny that statement.

So, what concept will now be used to stabilize the rupiah's
value at a proper level?

Bank Indonesia Governor Sjahril Sabirin then raised interest
rates on the central promissory notes (SBI) to a maximum of 45
percent per annum with the aim of pushing down the dollar's value
and curbing inflation.

When interest rates are high, people are expected to deposit
their money at commercial banks. As the rupiah supply then
decreases, demand for the dollar and thus its value should
decline. The dollar's value did decline slightly in the following
days. But will this measure be effective in the long term and
lower the dollar's value to Rp 5,000? No one can be confident of
this.

Sjahril's predecessor, Soedradjad Djiwandono, repeatedly
raised interest rates to prevent the dollar appreciating. When
the dollar surged drastically after the central bank's
intervention band was lifted and the rupiah allowed to float,
Soedradjad raised SBI interest rates to 30 percent per annum and,
in response, the dollar declined slightly. But he was then
pressured by businesspeople and Soeharto to lower interest rates
again. As a result, the dollar strengthened again.

As longer-term SBIs offer lower interest rates than one-month
certificates, it can be expected that the rates will be lowered
again in line with the dollar's gradual decline to an ideal
level. But won't people rush to dollars again if deposit rates
are cut and the dollar's value falls to Rp 7,000?

Another question is whether the increase in SBI interest rates
will help curb inflation. The answer is that the rate increase
will encourage people to put their funds in banks, which will in
turn reduce the money supply. Banks are not supposed to channel
their funds to productive sectors but use them for buying SBIs.
Only illiquid banks will be willing to risk losses by using
public funds, which are subject to high interest rates, for
buying SBIs. Money-losing banks will, sooner or later, have to be
closed down or salvaged by the Indonesian Bank Restructuring
Agency. But how can the government, which guarantees banking
liabilities, afford to cope with the banks' increasing bad loans,
that will surely increase further due to rising interest rates?

Another bit of good news has emerged -- an agreement on the
settlement of the private sector's foreign debt using Mexico's
1983 debt settlement as a model, under which debt principal
repayment was suspended for four years.

Some questions arise from this however. For example, will the
debtor companies, most of which are currently on the verge of
bankruptcy, still exist in four years' time if the dollar does
not weaken?

Will new credits flow into the country as soon as the old debt
problem is settled? It does not seem likely. Then, how can the
Indonesian economy survive, considering that the country, whose
current account always shows a deficit, has been largely
dependent on foreign investment since 1966. Poverty will surely
strike hard and deep, bypassing only the elite of high-ranking
government and military officials and politically well-connected
businesspeople.

What is the reality behind the Mexican model of debt
settlement? Mexico's economic crisis in the early 1980s was
actually settled by a single country, the United States. The
assets of Mexican debtor companies were taken over and used to
repay their debts to their creditors, most of whom were American.
That was why many Mexican companies were acquired by U.S.
businesspeople.

Even if Indonesians are willing to have their companies
acquired by foreign creditors, the value of the companies'
assets, in rupiah terms, are generally lower than their dollar
debts due to the sharp appreciation of the U.S. currency. So it
is how to see how the new foreign owners could benefit from the
acquired factories, which are too dependent on imported
materials.

So, what is the best solution? There is only one alternative
-- fixing the rupiah or a managed float of it in the same way the
country has survived for the past 25 years. To back up such a
measure, the government should provide adequate reserves of
foreign exchange, which it could acquire from foreign creditors,
for example, so that it can meet any rush on dollars.

But the IMF's reform policy must also be implemented
completely. Otherwise foreign borrowing will become a time bomb.