WSJ.com - Indonesia's Currency Crisis
WSJ.com - Indonesia's Currency Crisis
September 1, 2005
In news report after news report this week, the blame for the current slump in the value of Indonesia's rupiah has been laid almost exclusively at the door of soaring oil prices. The link has become so pervasive that the government of President Susilo Bambang Yudhonoyo -- alarmed by the decline of the currency, which fell to a four-year low of 11,750 against the dollar on Tuesday morning before rebounding -- has even moved to address the issue.
A package of measures announced by Mr. Yudhoyono last night included further reductions in fuel subsidies, although he failed to give any precise timetable. These currently make gasoline, for instance, a bargain in Indonesia -- at an average of just 24 cents a liter. But they exact a predictably high price, with the government spending $7 billion on the subsidies in 2004.
While any further moves toward the long overdue end of these subsidies are welcome, all this focus on higher oil prices has some of the hallmarks of a scapegoat that distracts attention from the underlying causes behind Indonesia's current woes. "It's always easier to avoid tough decisions by blaming an outside factor," economist Adam LeMesurier of Goldman Sachs told us yesterday. He points out that there's no reason why Indonesia, a major energy producer with the second strongest net oil position in Asia, should be more hard hit by rising prices than other countries in the region.
That's not to say reducing fuel subsidies won't be tough. When former President Suharto tried to do so in 1998, it sparked riots that ultimately led to his fall from power. An earlier round of subsidy cuts this February also provoked widespread protests.
But the broader point is that Indonesian leaders' reluctance to implement other crucial economic decisions have contributed at least as much to the present problems. That includes stalling on major regulatory reforms unveiled in January, which would provide a secure legal framework for foreign investment in important sectors of the economy.
Analysts and observers in Jakarta pin still more blame on Bank Indonesia, the nation's nominally independent central bank. Even as the rupiah began to fall last week, it resorted to excuses to avoid increasing interest rates -- before finally succumbing on Tuesday and raising its key one-month rate to 9.5% from 8.75%. That was too little, too late -- and Burhanuddin Abdullah, the central bank's governor, was forced to concede yesterday that more substantial interest rate rises may soon be needed.
All this could have been avoided if the central bank had acted when the country's monetary base first began to swell last year, as foreign capital flooded into Indonesia to take advantage of a then booming economy and equity markets. But raising interest rates is never politically popular, especially in an election year (Indonesians went to the polls three times in 2004, to elect a new president and parliament). Instead the central bank sat on its hands and ignored the signs of inflationary pressure.
According to an article by Steve Hanke of John Hopkins University that appears nearby, Bank Indonesia went even further. His analysis of its figures found that, far from acting to sterilize foreign-asset inflows to stop the monetary base from ballooning, the central bank augmented them with its own expansion of domestic credit. "The political monetary cycle was alive and well in Indonesia," Mr. Hanke concludes.
RELATED COMMENTARY
The Rupiah Revisited
By Steve H. Hanke
09/01/2005
That may have seemed like the most politically expedient course at the time but the chickens have now come home to roost. The cycle of monetary tightening, which started Tuesday, is almost certain to be much sharper and more severe than if the central bank had acted when warning signs first emerged early last year.
There is, of course, a surefire way to prevent politicians and central banks from acting according to expediency rather than what is best for the economy -- and that is a currency board that takes all discretion on such matters out of their hands. Under such a system, as successfully practiced in Hong Kong for more than 20 years, the exchange rate is fixed and market forces rather than a central bank determine interest rates and the supply of money. That can lead to wrenching adjustments in the short term, since it removes any discretion to step in and ease the process. But, as is evident from Indonesia's experience, it can also prove less painful in the long-term -- as it relieves pressure before it can build up into a currency crisis.
Indonesia had the chance to introduce a currency board in 1998, when Mr. Hanke was invited to Jakarta by Mr. Suharto to offer advice on its introduction during a previous rupiah meltdown. But that plan was scotched under heavy pressure from the Clinton administration and the International Monetary Fund, whose first priority seemed to be the former president's ousting rather than stabilizing the country's economy.
Seven years later, as Indonesia faces another currency crisis, it is doubtful the country is any better off as a result. Some Indonesian politicians continue to talk about the advantages a currency board would offer, but the idea has not been seriously discussed in government for many years.
Perhaps now, as Mr. Yudhoyono assumes an increasingly prominent role in economic policymaking, he will go beyond the short-term measures necessary to stop the rupiah's current slide to considering long-term solutions that would include another look at the currency board idea.
September 1, 2005
In news report after news report this week, the blame for the current slump in the value of Indonesia's rupiah has been laid almost exclusively at the door of soaring oil prices. The link has become so pervasive that the government of President Susilo Bambang Yudhonoyo -- alarmed by the decline of the currency, which fell to a four-year low of 11,750 against the dollar on Tuesday morning before rebounding -- has even moved to address the issue.
A package of measures announced by Mr. Yudhoyono last night included further reductions in fuel subsidies, although he failed to give any precise timetable. These currently make gasoline, for instance, a bargain in Indonesia -- at an average of just 24 cents a liter. But they exact a predictably high price, with the government spending $7 billion on the subsidies in 2004.
While any further moves toward the long overdue end of these subsidies are welcome, all this focus on higher oil prices has some of the hallmarks of a scapegoat that distracts attention from the underlying causes behind Indonesia's current woes. "It's always easier to avoid tough decisions by blaming an outside factor," economist Adam LeMesurier of Goldman Sachs told us yesterday. He points out that there's no reason why Indonesia, a major energy producer with the second strongest net oil position in Asia, should be more hard hit by rising prices than other countries in the region.
That's not to say reducing fuel subsidies won't be tough. When former President Suharto tried to do so in 1998, it sparked riots that ultimately led to his fall from power. An earlier round of subsidy cuts this February also provoked widespread protests.
But the broader point is that Indonesian leaders' reluctance to implement other crucial economic decisions have contributed at least as much to the present problems. That includes stalling on major regulatory reforms unveiled in January, which would provide a secure legal framework for foreign investment in important sectors of the economy.
Analysts and observers in Jakarta pin still more blame on Bank Indonesia, the nation's nominally independent central bank. Even as the rupiah began to fall last week, it resorted to excuses to avoid increasing interest rates -- before finally succumbing on Tuesday and raising its key one-month rate to 9.5% from 8.75%. That was too little, too late -- and Burhanuddin Abdullah, the central bank's governor, was forced to concede yesterday that more substantial interest rate rises may soon be needed.
All this could have been avoided if the central bank had acted when the country's monetary base first began to swell last year, as foreign capital flooded into Indonesia to take advantage of a then booming economy and equity markets. But raising interest rates is never politically popular, especially in an election year (Indonesians went to the polls three times in 2004, to elect a new president and parliament). Instead the central bank sat on its hands and ignored the signs of inflationary pressure.
According to an article by Steve Hanke of John Hopkins University that appears nearby, Bank Indonesia went even further. His analysis of its figures found that, far from acting to sterilize foreign-asset inflows to stop the monetary base from ballooning, the central bank augmented them with its own expansion of domestic credit. "The political monetary cycle was alive and well in Indonesia," Mr. Hanke concludes.
RELATED COMMENTARY
The Rupiah Revisited
By Steve H. Hanke
09/01/2005
That may have seemed like the most politically expedient course at the time but the chickens have now come home to roost. The cycle of monetary tightening, which started Tuesday, is almost certain to be much sharper and more severe than if the central bank had acted when warning signs first emerged early last year.
There is, of course, a surefire way to prevent politicians and central banks from acting according to expediency rather than what is best for the economy -- and that is a currency board that takes all discretion on such matters out of their hands. Under such a system, as successfully practiced in Hong Kong for more than 20 years, the exchange rate is fixed and market forces rather than a central bank determine interest rates and the supply of money. That can lead to wrenching adjustments in the short term, since it removes any discretion to step in and ease the process. But, as is evident from Indonesia's experience, it can also prove less painful in the long-term -- as it relieves pressure before it can build up into a currency crisis.
Indonesia had the chance to introduce a currency board in 1998, when Mr. Hanke was invited to Jakarta by Mr. Suharto to offer advice on its introduction during a previous rupiah meltdown. But that plan was scotched under heavy pressure from the Clinton administration and the International Monetary Fund, whose first priority seemed to be the former president's ousting rather than stabilizing the country's economy.
Seven years later, as Indonesia faces another currency crisis, it is doubtful the country is any better off as a result. Some Indonesian politicians continue to talk about the advantages a currency board would offer, but the idea has not been seriously discussed in government for many years.
Perhaps now, as Mr. Yudhoyono assumes an increasingly prominent role in economic policymaking, he will go beyond the short-term measures necessary to stop the rupiah's current slide to considering long-term solutions that would include another look at the currency board idea.
posted by Marcel at 2:26 AM
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