The credit crunch

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.