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.