Indonesia looks headed for currency board system
Capital controls seen in Suharto's talk of 'killing' strategy
By S N Vasuki
INDONESIA yesterday appeared headed towards a currency board system after
President Suharto declared that Jakarta had to determine a "certain"
exchange rate for the rupiah in order to stabilise the economy.
Economists also interpreted his warning that the government was
preparing a "killing" strategy to fight currency speculators as
suggesting that Indonesia was planning to impose capital controls as an
interim measure to reduce volatility in the rupiah.
The Indonesian rupiah was trading in the 9,600 rupiah range against the
greenback yesterday, after falling to 10,100 rupiah at one stage. A
modest intervention by Bank Indonesia did not lift the currency to
higher levels. At 9.30 pm last night, the rupiah was quoted at 9,800
against the greenback.
The rupiah is expected to remain volatile this week as financial markets
play the guessing game on where the rupiah-US$ fixed rate will be set
under the currency board system.
Mr Suharto made his comments at a meeting with members of the Indonesian
Council of Muslim Scholars yesterday morning.
"We have to determine a certain exchange rate so that all of our
companies can do their financial planning accurately," Mr Suharto said
without further elaboration.
Mr Suharto reserved his harshest remarks to foreign currency speculators
and warned that he would soon be introducing a "killing" strategy to
fight them.
"Intervention did not help. So in the near future, I will announce
measures to fight speculators," he said. "Please believe that we will
find a way to fight them. For that purpose, we need public support."
Rumours about Jakarta introducing a currency board have intensified in
recent weeks, particularly after a Feb 3 meeting between President
Suharto and Professor Steve Hanke, an American economist who is the
system's most ardent advocate.
Moreover, IMF managing director Michel Camdessus gave a cautious
endorsement of the currency board proposal over the weekend. "It's an
option available, but not the only one," he said, warning that such a
board would only work if Jakarta fully implemented the IMF-sponsored
reform programme.
Bank Indonesia governor Sudradjad Djiwandono yesterday confirmed that
the government was studying a proposal to establish a currency board but
stopped short of endorsing it. "We will see," he told reporters. "Don't
be in too much of a rush."
His ambiguous response has fuelled speculation in Jakarta that the
central bank, which was recently granted autonomy to set interest rates,
is not in favour of the proposal. Significantly, the impetus for
establishing the board appears to have come from the First Family, who
observers said are sold on the idea because it offers a solution to
stabilise the rupiah.
A currency board -- which was introduced in Hongkong in 1983 and
Argentina in 1991 (both in the aftermath of a severe crisis of
confidence) -- is contingent on the government meeting two basic
principles.
First, the government will need to give a constitutional commitment to
exchange domestic currency for US dollars at a pre-determined fixed
exchange rate. The central bank would cede its authority to the currency
board and focus primarily on supervising the banking sector.
Second, the currency board can only issue currency if it is backed by US
dollar reserves.
There is some concern that Indonesia's limited foreign exchange reserves
-- estimated at US$20 billion (S$33.2 billion) -- was a major barrier to
the establishment of a board but economists feel that this is not
insurmountable.
Stockbroking firm Socgen Crosby said in a recent report that credibility
was the key for the successful establishment of a currency board. It
said credibility "is derived from the full US dollar backing and
constitutional impossibility of changing the arrangements".
"The key is willingness to allow interest rates to rise to high levels,"
it said. "Given that the rates are already at high levels, the marginal
costs on the economy is unlikely to be large in this case."
Indonesian interest rates are already amongst the highest in the region
and the IMF programme commits the government to taking a tight monetary
stance.
Mr Suharto yesterday drew a link between stable exchange rates and
social unrest. "If our industries cannot get raw materials, they will
halt operations," he said. "If industries stop, there will be
unemployment and unemployment will trigger unrest."
Financial markets generally welcomed the move to establish a currency
board, including the suspension of currency convertibility.
"The government can suspend convertibility of the rupiah as a temporary
measure. Indonesia has a case because it is in the process of revamping
its banking system," said Socgen Crobsy's Neil Saker. "This will help in
limiting the outflow of capital in the short-term and full
convertibility can be restored once the situation stabilises."
However, Ng Bok Eng at the Daiwa Institute of Research feels that the
imposition of capital controls will send a disturbing signal to
financial markets.
"The government will shoot itself in the foot if it resorts to such a
measure," he said. "It will never work because foreign exchange markets
are not fluid."
In other developments, several hundred protesters marched to the main
Jakarta office of Bank Indonesia yesterday calling for the resignation
of Governor Djiwandono. The protesters, who were allied to opposition
leader Megawati Sukarnoputri, criticised the central bank's policies
which they said had led to a weak rupiah and rising prices. |
