The strengthening rupiah

The strengthening rupiah

The strengthening rupiah and moderating the volatility of its
exchange rate since last year have created a virtuous cycle
within the economy, further bolstering macroeconomic stability.

The steady appreciation of the local unit against the American
dollar from as low as Rp 10,420 in January 2002 to as high as Rp
8,100 this week has allowed the central bank to continuously ease
its monetary policy by bringing down its benchmark short-term
interest rate to below 11 percent from as high as 17 percent in
January 2002.

The stronger rupiah will, first of all, reduce government
spending on servicing its foreign debts in the current fiscal
year that assumes the rupiah's exchange rate at a range of Rp
8,500 to Rp 9,500 to the U.S. dollar and bolster the export
competitiveness of manufacturing companies, which depend on
imported materials and components.

The local unit's appreciation will significantly cut down the
production costs of electricity, thereby enabling state
electricity company PLN to cancel the quarterly increase of 6
percent in its power rates already mandated for the whole year.
Likewise, government spending on fuel subsidies will most likely
be less.

Further down the line, a stronger rupiah will decrease
pressures of imported inflation and help check cumulative
inflation this year to less than the 9 percent to 9.5 percent
range envisaged for the fiscal year. In fact, cumulative
inflation in the first four months was less than 1 percent,
compared to 3.26 percent in the same period last year.

This development in turn will give more leeway for the central
bank to further lower its benchmark interest rate, and this will
decrease government spending on servicing its domestic debts.

It has officially been estimated that a decline of each
percentage point in the interest rate will decrease the
government's service burden on its domestic debts by almost Rp 2
trillion (US$242 million). The central bank's interest rate has
declined steadily from 12.84 percent in January to less than 11
percent this week, compared to the average 13 percent assumed for
the whole fiscal year.

It is also comforting to learn that the positive developments
have been generated largely by domestic factors. A weakening
dollar did contribute to the rupiah's appreciation, but the
improving fundamentals of the economy have been the biggest
source of the rupiah's strength.

Analysts attribute the rupiah's strength mainly to the
solidifying political stability, steady increase in gross foreign
reserves to as much as $34 billion now and the significant inflow
of portfolio capital to the stock and bond market. The
significant progress in the restructuring of corporate foreign
debts has reduced the demand for dollars as the repayment period
of most debts has been rescheduled.

Critics of the International Monetary Fund program in
Indonesia need to be reminded that more than $10 billion of the
international reserves was derived from IMF balance of payments
assistance. Even though these loans cannot be used for the state
budget, they have contributed significantly to increasing the
country's foreign reserves to such a level that is greatly
effective to bolster market confidence in the rupiah and deter
speculative trading on the currency market.

The concern that further appreciation of the rupiah would hurt
exports seems premature because the rupiah is still far from what
analysts and the central bank consider overvalued.

Moreover, experience has shown that rupiah depreciation has
never been a major influence on export competitiveness. Security,
smooth transportation, easier port handling, efficient customs
clearance and low interest on working capital loans have instead
been the strongest boosters of export competitiveness. Without
these preconditions, exports would remain depressed even if the
rupiah were to fall to as low as Rp 10,000, as it did in 2000 and
early 2001.

The question now is whether the steady rupiah appreciation
will be sustainable.

Most analysts are confident the virtuous cycle will continue
if the government remains firmly committed to its structural
reform agenda. The rupiah will appreciate at an even faster rate
if the next few months see more positive developments that
increase business confidence.

A smooth initial public offering by Bank Mandiri, the
country's largest bank, and the strategic sale of Bank Lippo
within the next few weeks will contribute further to the virtuous
cycle. A higher pace of asset disposal by the Indonesian Bank
Restructuring Agency will provide another building block for
market confidence.

Credible preparations for exiting the IMF program later this
year will further strengthen market confidence and enable the
economy to weather the political turbulence expected in the 2004
election year.