Temporary relief for rupiah

Temporary relief for rupiah

The tighter money policies launched by Bank Indonesia (BI) on
Tuesday, though rather overdue, have succeeded in shoring up the
rupiah, which earlier fell to a five-year low of Rp 11,800 to the
American dollar in the morning, to Rp 10,525 at the afternoon
close. The local unit strengthened further to Rp 10,400 on
Wednesday.

Bank Indonesia raised its BI Rate by 75 basis points to 9.5
percent and its one-week overnight rate by 100 basis points to
8.5 percent and signaled a steep rise shortly in banks'
compulsory reserve requirements at the central bank and more
intensive monitoring of foreign exchange transactions.

All this aims at soaking up excess liquidity on the market and
consequently reduce the ammunition for speculative trading on the
local unit.

President Susilo Bambang Yudhoyono's special pronouncement on
Tuesday that he and the central bank would be introducing on
Wednesday night a new package of concerted measures to beef up
the rupiah also help allay the public's concern that the
government's economic policy-making machinery was in disarray.

The President seemed to have realized that the daily
operations of the financial market run on perceptions and not on
economic fundamentals that change on a monthly basis. Market
perceptions can change from day to day because they are formed by
information and statements from the government and political
leaders.

The central bank is really in a dilemma about how it manages
the rupiah rate. The interest rate policy can be used only
sparingly in view of its devastating impact on the state budget,
in view of the Rp 647 trillion (US$65 billion) in government
bonds already issued. Much higher interest rates would also
sabotage the nascent consumption-fueled recovery and further
choke businesses.

Bank Indonesia is also prudent for having refrained from too
deep intervention into the market when the rupiah came under
strong speculative attacks over the last two weeks because such a
measure would waste the limited stock of its precious foreign
reserves -- worth about $32 billion.
After all, the root cause of the fall is the negative market
sentiment with regards to the government's policy-making
capability and its fiscal sustainability.

A stronger enforcement of the central bank's ruling of April
2000 on foreign exchange (forex) transactions is also welcomed.
The ruling requires all citizens and foreigners holding stay
permits and Indonesians residing overseas to submit to Bank
Indonesia through their banks much more detailed report documents
on every forex transaction in excess of $10,000. This up-to-date
reporting will provide the central bank with accurate,
comprehensive and timely data on forex deals to enable it to have
a better view of the position of the external balance and
international investment, a prerequisite for devising effective
monetary policies.

Highly commendable though was that the government, in spite of
the devastating impact of the rupiah's free-fall, did not resort
to slapping forex controls as these would be draconian measures
that could cause total panic and chaos.

As the President observed on Tuesday, the current condition
has little resemblance to the situation that preceded the 1998
economic and political crisis.

What we are facing now is a crisis of confidence in the
government and its fiscal management that set off a run on the
rupiah as people scrambled to protect their savings and rupiah
assets. What has been taking place in the currency market since
Aug. 18 is a flight to quality but it is not yet a flight to
safety -- as was the panic that occurred in early 1998 when
people dumped their rupiah at whatever rate for the dollar.
However, this crisis, if not resolved once and for all, could be
self-fulfilling and escalate into a panic.

Monetary measures by the central bank alone will not be enough
to maintain a stable rupiah at the desired level of 9,500 for
this year and 9,400 for next year unless the government acts
firmly and immediately to remove the uncertainties about its
fiscal management.

The package of measures President Susilo must announce should
therefore stipulate: Clear-cut, definitive scheduling for the
phasing-out of fuel subsidies by gradually floating domestic fuel
prices on international market quotations; a credible mechanism
of social safety nets for the poor to help them weather the
general price rises within the coming months; and more concrete
measures to improve the investment climate and help businesses
cut costs.

Anything short of this package would leave the economy highly
vulnerable to high oil price fluctuations, which are entirely
beyond the government's control.

As we have repeatedly argued in this column, the billions
dollars wasted annually for fuel subsidies for the middle and
high-income group could have been invested far more usefully in
education, health services and rural infrastructure.