Stronger rupiah masks a dangerous economic paradox

Stronger rupiah masks a dangerous economic paradox

The rupiah is strengthening in value despite deterioration in
the Indonesian economy. Economist Kwik Kian Gie discusses the
paradox inherent in the recent performance of the currency.

JAKARTA (JP): The rupiah strengthened to Rp 7,600 against the
U.S. dollar in late October. Although it has since fallen back to
around Rp 8,000, it is still trading well above the conversion
rate of Rp 10,000 to the dollar set as a year-end target by the
International Monetary Fund (IMF).

In some circles, the word is that Indonesia's monetary crisis
is over, that the rupiah has bottomed out and that the Indonesian
economy is now therefore ready to recover. Even the Nov. 4
meeting of Cabinet ministers responsible for the economy was full
of optimism.

Coordinating Minister for Economy, Finance and Industry
Ginandjar Kartasasmita said after the meeting that the recent
decline in the rupiah's value was temporary and that it was
likely to strengthen again after the Nov. 10 to Nov. 13 Special
Session of the People's Consultative Assembly (MPR) is over. Bank
Indonesia Governor Syahril Sabirin also said the central bank
would continue to release an adequate supply of U.S. dollars onto
the market.

A strengthening in the rupiah is expected to restore foreign
investor confidence in the Indonesian economy and encourage them
to return to the country, capital in tow.

But do these developments in the rupiah's exchange rate
indicate that President B.J. Habibie's Cabinet has succeed in
setting the economy to right during its first five-months in
office? It does not seem so.

The increase in the value of the rupiah was not supported by
an improvement in the fundamental factors of the economy, which
instead deteriorated at the same time.

Deterioration in the economy has forced banks to raise deposit
rates to around 60 percent per annum, a level alluring enough to
encourage dollar holders to deposit their money in the country.
By depositing Rp 800 million (US$100,000) in a bank offering an
annual interest rate of 50 percent, for example, an investor,
within one year, will earn Rp 400 million or $50,000, 10 times
more than the $5,000 he would earn by depositing his money in
dollars at an interest rate of 5 percent per annum.

Thus, high interest rates have helped to increase demand for
the rupiah and propped up its value.

However, does an interest rate of 50 percent per annum
indicate a healthy economy? Surely not and therein lies the
paradox of the rupiah -- its value has increased while the
economy is deteriorating.

Another factor propping up the rupiah is the fact that the
government does not own an adequate amount of the currency to
finance its own expenditure. For example, to subsidize food
supplies and finance routine expenditures, the government has
been forced to take out dollar-denominated loans from overseas
creditors and spend them in rupiah.

By selling dollars, the government has increased the dollar
supply on the money market which has a beneficial effect on the
rupiah.

Thus, deterioration in the economy has forced the government
to seek foreign aid, the spending of which is propping up the
value of the rupiah. It's a paradox.

Besides those factors, the increase in the value of the rupiah
has also been helped by an external factor -- a weakening in the
dollar's value against other major currencies.

Deterioration in the economy will increase the burden on the
next generation of this nation. They will have to work hard to
earn money to repay the debts belonging to this generation of the
country's leaders.

The government's outstanding foreign debt, which stood at
around $53 billion before the start of the monetary crisis in
July 1997, will be increased substantially by disbursement of the
$43 billion bail-out fund made available by creditors coordinated
by the IMF, the $8 billion advanced by the Consultative Group on
Indonesia (CGI) and a further $6 billion in humanitarian aid
advanced by various donor countries and organizations. Added to
the private sector's foreign debts of $80 billion, Indonesia's
offshore borrowing will reach $190 billion, or Rp 1,520 trillion,
a staggering 3.6 times higher than the country's gross domestic
product (GDP) prior to the economic crisis.

Deterioration in the economy has also been marked by an
increase in bad loans, which are now thought to be larger than
the country's GDP. A solution to this problem is still a long way
off because it must be related to a scheme designed to recover
more than Rp 140 trillion Bank Indonesia advanced as liquidity
support to struggling commercial banks. The government, which
last month gave indebted banks one year to repay their loans, is
now considering making changes to the repayment scheme.

Can the rot be stopped? The economy will improve if political
stability returns to the country, but this can only be achieved
if the People's Consultative Assembly (MPR) and the House of
Representatives (DPR) are populated by members who are truly
representative of the nation and who are capable of appointing a
legitimate government with the broad support of the public.

If this does not happen, rioting will return to the country
with all the usual detrimental effects on economic activity.

The Special Session running from Tuesday to Friday provides
members of the MPR, who themselves were illegitimately appointed
in 1997, with a chance to approve policies which will pave the
way to democracy and satisfy the aspirations of the people. If
they fail to do so, Indonesia will enter a gloomy era of anarchy
shortly after the session closes. Individual elements of society
will start to issue unilateral demands for their own individual
rights to be met and take the law into their own hands to ensure
this comes about.