The credit crunch

It is still too early to gauge whether the value of the rupiah, against the American dollar, has finally bottomed out. True, the speculative attacks on the currency are no longer as fierce or massive as those witnessed during the first three weeks of this month. And the rupiah has been fairly stable at a range of 2,750 to 2,850 over the past four days.

But this range cannot be immediately accepted as a sustainable market rate because it has, so far, been greatly supported by economically punitive interest rates.

The rupiah has not yet been subjected to the normal market test, meaning that the economically unacceptable, high interest rates have yet to undergo gradual lowering. At the present interest rates of 28 percent to 30 percent, for Bank Indonesia's short-term certificates (one to three month maturity), it is obviously much more profitable to invest money in rupiah papers rather then holding dollar positions.

This, we think, is the dilemma being faced by the monetary authorities. They are apparently not sure whether the range of the rupiah rate over the past few days is sustainable in a market with lower interest rates.

On the other hand, though, the longer the credit crunch is maintained, the greater the cost to the long-term foundations of the economy. Most businesses, including banks, have been crying out for relief from the high interest rates. Several businesses have even hinted at being on the brink of collapsing. Investor confidence in the long-term prospects of the economy are bound to be seriously damaged if the Jakarta Stock Exchange, which already lost about 23 percent in market capitalization, continues to be depressed by the higher interest rates.

The businesspeople's complaints are legitimate. Sensible people, who have a disposable income or own some savings, will not risk their money in businesses when they can sleep and still earn 28 percent to 30 percent in interest without any risks. Moreover, no business can compete in the market if its capital costs amount to more than 2.5 percent a month.

Businesses also are finding it impossible to operate normally with the rupiah rate fluctuating wildly. As they cannot make any reasonable calculations, they are not able to negotiate any deals.

The central bank therefore should consider lowering the interest rates in a gradual manner to allow the rupiah to settle at a sustainable market rate. The sooner the rupiah rate settles, the smaller the cost of "shock-therapy" being used to cope with the currency crisis. It is not unthinkable that a long credit squeeze would lead to a banking crisis with equally devastating implications for the whole economy.

There are now two major challenges facing businesspeople. First, they have to adjust to a new market reality whereby the rupiah rate no longer develops within the band, once set and protected by the central bank, but according to the market forces. While this adjustment is already a very taxing one, they are also required to start adjusting their prices according to the new rupiah rate. It is unlikely the rupiah will return to the 2,378 to 2,682 band which was set by the central bank in early July.

We believe businesspeople have now accepted that they must live with a wider trading range. What they urgently need, to enable them to operate normally with reasonably calculated risks, is a reasonably stable range. After all, even before the rupiah floating, businesses had become accustomed to calculations with a 12 percent fluctuation in the rupiah rate. The difference now is that the range of the rupiah rate is no longer protected by the central bank but is based largely on the market forces.

The monetary authorities could help businesses survive the painful adjustment by creating a more conducive climate for the market to determine a sustainable range for the rupiah rate. We do not think the rupiah will be able to settle at a sustainable market rate if the current credit crunch and astronomically high interest rates are maintained. The high interest rates at present are only creating an artificial rate for the rupiah.