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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

Suharto's Gamble

Will a currency board help fix Indonesia's woes?

By Assif Shameen


IT STARTED ABOUT TWO weeks ago when Steve Hanke was summoned to Jakarta. The American economist had proposed that Indonesia peg its currency to the U.S. dollar to help stabilize the economy. President Suharto's eldest daughter, Tutut, reportedly called Hanke in Istanbul and asked him to brief her father. Things began moving rapidly. On Feb. 9, Suharto told a meeting of Muslim clerics that the country will soon fix a certain exchange rate for the rupiah. Two days later, Finance Minister Mar'ie Muhammad confirmed the plan. Indonesia will soon create a currency board. "At the moment, the government is preparing the supporting framework, including the regulations," he told legislators.

Good move? The markets seemed to think so. The rupiah jumped 28% to 7,600 to the dollar after Suharto's comments -- where it remained after Mar'ie's parliamentary appearance. At one point in January, it had traded at 17,000. Other Asian currencies also appreciated. "A currency board has never ever been broken by anyone," says Sani Hamid, a currency analyst at MMS International in Singapore. "It will certainly help stabilize things in Indonesia and allow companies there to square off their debt and start operating again." The African country of Djibouti has had a currency board since 1949. Hong Kong pegged its currency to the dollar in 1983. Other countries with a similar system include Argentina, Estonia and Bulgaria.

The worry is that Indonesia will be the exception that proves the rule. Under a currency board arrangement, the central bank guarantees the redemption of all notes in circulation at a set exchange rate to the dollar or another foreign currency or basket of currencies. "It's a very severe system," says George Soros, the financier who reaped a $1-billion windfall when he bet against British sterling in 1992. "If there is pressure, interest rates have to go up." That could lead to a liquidity crunch -- and corporate bankruptcies across the board. On the other hand, says Sani, "if the peg is too successful, there could be a massive inflow of foreign money." The rupiah could test new highs, eroding the country's export competitiveness.

Does Indonesia have the dollar reserves to support a peg in the first place? At the moment, it has about $19 billion. That may be too little to back an exchange rate of between 5,000 rupiah to 6,000 rupiah to the U.S. dollar. (The 1998 budget assumes an average exchange rate of 5,000 to the greenback.) The International Monetary Fund has arranged a $33-billion rescue package, but some fear it may withhold the money. The IMF, along with Suharto's economic officials, are said to have been kept in the dark about the currency-board plan. On the day Mar'ie confirmed the scheme, the Fund sent a strongly worded letter warning against a premature introduction of a peg.

At the root of all the doubts is Suharto himself. "The risk is that [a currency board] will be used as a political weapon to deal with an imminent political problem," says John Greenwood, one of the architects of Hong Kong's currency peg. Suharto is up for re-election next month. Some in Indonesia are suspicious of the involvement of Tutut and other presidential relatives. "Who is the currency board supposed to benefit?" asks an economist. "It seems that Suharto is trying to bypass the IMF letter of intent." After being seen as reneging on initial promises of reform to the Fund, the government signed a revised IMF agreement in January pledging to dismantle monopolies and stop huge infrastructure projects. The Suharto family is a beneficiary of many of them.

Even with a peg, currency flight is a possibility. The government can impose capital controls. "But if I can't convert the local currency into dollars, why would I hold the rupiah or invest in the country?" asks Eric Nickerson of Bank of America in Hong Kong. Desmond Supple of Barclays Capital in Singapore is especially worried about Indonesian banks. "The fragile system cannot survive the liquidity crunch created by the currency board," he says. "Even if Indonesia allows some banks to fold, it will still need to recapitalize some institutions. High interest rates will cripple the economy and create social instability. I doubt if the leadership has the fiscal and political will."

The peg may then have to be broken. "That would be a doomsday scenario not just for Indonesia but for the rest of the region," warns Supple. "I bet the rupiah would go to 20,000 to 25,000 in a day." He says a currency board is not the solution: "If it were, Malaysia and Thailand would have fallen for it in September." What is the remedy? Move on real restructuring reforms, like the tough IMF programs that South Korea and Thailand are now beginning to implement. "The key is stiff medicine, not dressing up the patient to look good," says Supple.

Initiatives such as Malaysia's proposal to use ASEAN currencies in bilateral trade and aid from the G-7 industrial countries to prop up the rupiah may help. But confidence in Indonesia can be restored only by Indonesians. The aging Suharto has yet to designate a credible successor and convince the world that he will really level the business playing field. A currency board is not likely to become the panacea that he and his children seem to think it would be.

-- With reporting by Jose Manuel Tesoro / Jakarta


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