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.