The falling dollar and the rupiah

The falling dollar and the rupiah

The euro and most major Asian currencies have recently risen
sharply against the American dollar. Last week alone, the euro
appreciated by almost 2 percent to an all time high of US$1.32.
The Japanese yen has strengthened by 8 percent since October, and
the South Korean won by nearly 10 percent. Likewise the Taiwanese
and Singapore dollars have been at their highest levels for three
and six years, respectively. The rupiah, however, has remained
weakly stable at between Rp 8,950 and Rp 9,050.

Is the dollar heading towards a crisis, as Fred Bergsten of
the Institute for International Economics predicted in October?
Or was the steep fall last week simply a provisional fluctuation?
It is still too early to conclude that the greenback's demise is
only a matter of time. Many analysts have cried wolf too often.

The dollar's role as the world's reserve currency is still too
important for such major holders of dollar assets as Japan,
China, Taiwan and South Korea and other East Asian countries to
sit back and allow it to crash. China alone is estimated to hold
about $330 billion, or two thirds of its foreign reserves, in
dollar-denominated assets. In total, East Asian countries are
estimated to hold $2 trillion in dollar-denominated assets, not
to mention those held by Europe.

There are therefore codependent relationships between the U.S.
and its trading partners in Asia and Europe, and they have a
vested interest in maintaining the status quo (a stable dollar).
Europe fears that a steep decline in the dollar will adversely
affect its exports and consequently its growth. Likewise, China
may consider losses in its dollar assets less significant than
the losses of millions of jobs stemming from a weaker dollar.

It is thus in the best interests of most countries to have a
soft landing for the dollar. Most East Asian countries would not
likely allow revaluation of their currencies against the
greenback as long as China continues its own peg to the dollar at
its current rate. But China probably won't succumb to pressures
for yuan revaluation because its financial system is not yet
ready and its fragile banking system could not cope with
unpredictable swings in exchange rates.

However, many countries are becoming increasingly impatient
with U.S. stubbornness in continuing to live beyond its means,
and therefore intend to convey a stronger warning to the U.S..
Hence, there are several strong factors behind the steep fall in
the American dollar over the past week.

Major trading countries are becoming increasingly alarmed
about the ballooning U.S. current account and budget deficits. A
recent admission by Fed Chairman Alan Greenspan that the American
current account deficit is already unsustainable, also acted to
dampen foreign appetites for dollar assets. Consequently, several
central banks may have started shifting part of their foreign
reserve holdings out of American dollars.

What is Indonesia's position in all this uncertainty? Although
Indonesia is a minor player within international foreign exchange
markets, movements in the dollar's rate impact both its balance
of payments position and its fiscal management. It is worth
recalling that the bulk of Indonesia's foreign debt of more than
$130 billion is denominated in the American unit, and so are its
export earnings.

Indonesia is therefore highly vulnerable to wild fluctuations
in the dollar. It is a comfort to hear a remark by an executive
of Bank Indonesia last week that the central bank is closely
monitoring the dollar rate movements in light of realigning the
composition of its foreign reserve holdings that total the
equivalent of $35.4 billion.

Indonesia's biggest concern, though, is not the potential
losses in foreign reserve holdings on account of a weaker dollar,
but the damage a wildly fluctuating dollar will do to our economy
as a whole. Certainly, a hard-landing dollar may set off a global
recession and this in turn will hit Indonesian exports, the
second locomotive of its economy, apart from private consumption.

The fact that the rupiah has remained fairly stable against
the dollar over the past week, while most major Asian currencies
appreciated against the greenback, is rather strange.

This demonstrates the fragility of the Indonesian currency in
spite of the big inflow of portfolio capital over the past month.
It was this capital inflow that was mainly responsible for the
steep rise in the Jakarta stock exchange index to an all-time
high of 965. But portfolio capital can take flight at the
slightest sign of trouble for the rupiah.

This development also showed that most Indonesian exporters
still prefer keeping their export earnings overseas, and further
confirmed analysts' views that both foreign and domestic
investors remain in a wait-and-see position.

Given this fluid international foreign exchange market, it is
imperative that the government kick-starts the work of regaining
the confidence of foreign investors. A robust pace of foreign
direct investment can be quite effective in assisting the nation
weather fluctuations in foreign exchange markets.