"The management of the IMF welcomes the timely decision of the Indonesian authorities. The floating of the rupiah, in combination with Indonesia's strong fundamentals, supported by prudent fiscal and monetary policies, will allow its economy to continue its impressive economic performance of the last several years."-International Monetary Fund Deputy Managing Director Stanley Fischer, on Aug 15, one day after Indonesia floated the rupiah.
Mr Fischer, it should now be apparent to all, was wrong. In fact, the IMF has consistently misjudged Indonesia. And yet this same institution is now using its considerable political and financial muscle to prevent Jakarta from taking the one step that could save the country, establishing a currency board.
This pressure is coming from the very highest level. Michel Camdessus, the IMF's managing director, sent the Indonesian government a strongly worded letter threatening to cut off aid if Indonesia establishes a currency board. U.S. president BillClinton, whose administration seems to have put blind trust in the IMF, last Friday made a personal telephone call to President Suharto reportedly supporting the IMF's position.
But opposition to a currency board is misguided. A currency board is the only system under consideration that would achieve what both Indonesia and the IMF want, a sound currency to support a return to high economic growth.pAfter Indonesia floated the rupiah against the U.S. dollar last August, with the IMF's blessing, the rupiah began a depreciation that reached 85% before the rally of the last three weeks. The IMF then made matters even worse. Its first attempt to help banks created panic because the IMF proposed giving deposit insurance to government-owned banks only. Depositors started withdrawing money from some privately owned banks, threatening to bankrupt them, until insurance was extended to all banks. And in January the IMF had to revise its November program to reflect that in just two months the currency and the economyhad gotten much worse.
To be fair to the IMF, almost all other observers also misforecast Indonesia, but the institution should learn from the past. Its approach in Indonesia has simply not ended the currency crisis or the steep decline of the economy.
The IMF's approach has not worked because it has not addressed the currency crisis. The IMF's current program with Indonesia (summarised in the IMF's World Wide Web site) has seven parts keeping inflation below 20 per cent while avoiding a recession; holding the government budget deficit to 1 per cent of gross domestic product; moving shadow off-budget government spending into the budget; cancelling some wasteful spending projects; giving the central bank "Full autonomy" in monetary policy, in particular allowing it to charge high interest rates; restructuring banks and companies; and ending trade restrictions that benefit privileged business interests at the expense of the public.
Notice that not one of these items amounts to a direct step to stabilisethe exchange rate. Indonesia could fulfil every part of the IMF program, yet still have a rapidly depreciating rupiah. Not all of the bad news about the Indonesian economy is known yet, but the currency crisis does not seem to be the fault of the usual suspect, excessive deficit spending by the government. Rather, the crisis results from uncertainty about SE Asia generally, the Indonesian government specifically, and how much further the government and the central bank will let the floating exchange rate depreciate.
Central banking in Indonesia, as elsewhere, lacks built-in restraints. Bank Indonesia is free to print as much money as it wishes. Providing a stable currency through Bank Indonesia is therefore a tricky business. During the nearly 50 years that Bank Indonesia has existed, the rupiah has fallen to less than a millionth of its original value against the U.S. dollar. The future value of the rupiah is unpredictable. People have little reason to hold untrustworthy rupiah rather than trustworthy U.S.dollars, even at interest rates of 40 per cent or 50 per cent a year. A depreciation such as the rupiah has just suffered would more than offset the advantage of such high rates.
A currency crisis of this magnitude threatens to make the IMF program irrelevant, because the waves of the crisis are sinking the Indonesian economy. The prices of imports have risen, inflation is following, and businesses that owe foreign debt cannot repay it. A chain of bankruptcies has begun.
Bankrupt business cannot repay their bank loans, so the banking system faces collapse. The government will be tempted to socialise losses by using government budget deficits and money printed by Bank Indonesia to compensate the losers. The likely result is high inflation and a deeper recession than Indonesia is already entering.
The way to end the currency crisis is to address it forthrightly, and that is by stabilising the exchange rate. A currency board will do just that. A stable exchange rate at the level that has been discussed -5,000 to 5,500 rupiah per dollar - will enable many Indonesian companies that now cannot repay their foreign debt to begin doing so. It will limit fresh inflation, though some inflation has already occurred that must work its ways through the system.
A currency board will make Indonesia better able to fulfil the IMF program. Because an orthodox currency board holds only foreign reserves, it cannot finance government budget deficits directly or, as Bank Indonesia can, even indirectly.
That will restrain government spending and create pressure to restrain off-budget spending and wasteful spending projects. A currency board, unlike a typical central bank, has true "full autonomy" in monetary policy because it is completely rule-bound and has no discretion to use its resources for political ends.
The IMF has claimed that Indonesia does not yet meet some of the conditions necessary to establish a currency board, in particular a sound banking system. The IMF has it backwards. The whole banking system, ratherthan just a few banks, is in trouble because the currency crisis has created problems throughout the economy. Stabilising the exchange rate is essential to fixing the banking system. It is possible to restructure the banking system without a central bank. Argentina did so during its 1995 banking crisis. The bank restructuring fund that Indonesia recently established could work like the similar Argentine fund. The IMF supported Argentina then, and the results were good. It should support Indonesia now.
By arrangement with The Wall Street Journal
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
