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.