Jakarta's Plan To Peg Rupiah Powers a Rally Across Region
International Herald Tribune
February 12, 1998
Thomas Crampton

Despite the opposition of the World Bank and the doubts of many economists, Indonesia confirmed Wednesday that it intended to stabilize its battered currency by pegging it at a fixed rate.

The announcement that Indonesia would move to a system known as a currency board added momentum to a three-day rally of Asia's beleaguered currencies.

Economists warned, however, that the currencies would almost certainly retreat once again as the region heads into the next phase of economic turmoil.

"We are now in the closing pages of Chapter 1 of this crisis," said Jan Lee, chief economist at Hongkong and Shanghai Banking Corp. "The worst of the liquidity crisis is over, and we are entering Chapter 2: economic adjustment."

Mr. Lee and other economists said the next phase would be painful and include:

Sharp falls in economic growth and a slew of corporate bankruptcies.

Rising mass unemployment and the threat of increased social unrest.

High inflation.

Continued concern about a competitive devaluation of China's currency, the yuan, which could set many currencies in Asia tumbling anew.

"This is a false dawn, the economic and political fundamentals are just not supportive of this rally," Mr. Lee said, adding that he believed the currencies would not sustain their current level for more than a week.

"There is a lot of euphoria, and the risk is that this new confidence starts to live on expectations of change rather than real change," said Bernhard Eschweiler, head of economic research for Asia at J.P. Morgan. "Before we get any recovery we need to have some very serious finance sector reform."

In Indonesia, meanwhile, President Suharto blamed a "plot" by unnamed enemies seeking to destroy Indonesia's economy for the rupiah's fall.

"There are signs that this monetary crisis has been engineered to smash our economic development of the past 30 years," he said. (Page 4)

On Wednesday, the rupiah made a 6 percent gain against the dollar on top of the 30 percent surge it made a day earlier to close at 7,020 rupiah to the dollar.

The gains came as Indonesia's finance minister, Mar'ie Muhammad, confirmed that Jakarta was "preparing the supporting frameworks, including the regulations" for a currency board that would peg the rupiah to the dollar.

Other regional currencies also rose, including the Thai baht, which surged nearly 9 percent to 41.75 baht to the dollar; the Malaysian ringgit, which jumped almost 5 percent to a three-month high of 3.38 ringgit to the dollar, and the Philippine peso, which rose more than 4 percent to 37.57 pesos to the dollar.

Foreshadowing the problems of unemployment that will hit throughout the region, the South Korean won — the only currency to fall — was brought down as powerful unions threatened a general strike on Friday to stop layoffs.

Market approval for the Indonesian currency board stems from the stability it would give the rupiah and the way it removes political interference from monetary policy by essentially closing the central bank.

A currency board would legally bind the rupiah to other currencies, probably the dollar, at a stated rate of exchange, thereby coupling Indonesia's monetary policy to decisions taken in Washington by the Federal Reserve Board.

Currency boards, which are in place in Hong Kong, Argentina and several other economies, hold onto a reserve of dollars or other currency equivalent to the national money supply. When any local currency is converted into dollars, the national money supply shrinks, forcing banks to pay higher rates of interest.

Critics doubt that Indonesia has sufficient reserves to back a currency board fully.

They also warn that Indonesia's already struggling banks would be unable to pay high interest rates and that strict controls would have to be in place to stop a rush for dollars when the system was put into place.

The punishingly high interest rates could also hurt economic growth just as the country is attempting to regain momentum. "With no central bank guaranteeing deposits if banks go under, there is a risk that panic withdrawals will start all over again," Mr. Eschweiler said.

Advocates of the currency board admit that it is not a perfect solution, but say that it offers a way to stop the volatility afflicting Asian currencies.

"The currency board would create some problems, but at least you have the possibility of things getting better," said Neil Saker, head of regional economic research at SocGen Crosby Securities.

Mr. Saker added that only when countries adopt currency boards do they gain the stability needed to settle payments for trade in local currencies, a concept being promoted by Prime Minister Mahathir bin Mohamad of Malaysia.

Last week Mr. Mahathir toured Southeast Asia to push for the use of local currencies instead of spending precious dollars.

While he received a polite welcome from his hosts, officials from other Southeast Asian countries privately admit that they are discouraging a plan that economists and currency traders say makes little sense.

"We have tried to explain it to Mahathir," the commerce minister of a Southeast Asian country said in a recent interview, requesting anonymity. "In the current situation, trade in your own currency just amounts to barter."

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