A confrontation between the International Monetary Fund and Indonesia's President Suharto may mean the withdrawal of IMF funding for Indonesia's shattered economy, with unforeseen consequences for the rest of the Asian economies.
President Suharto, advised by American economist Mr Steve Hanke, wants to create a currency board to stabilise the Indonesian currency by linking it with the US dollar at a fixed rate. The collapse of the rupiah has plunged the country into crisis and left most of its major companies technically bankrupt. IMF managing director Mr Michel Camdessus strongly disagrees. "In the present circumstances," he said in a letter to President Suharto, leaked to the Washington Post on Saturday, "if a currency board proposal were adopted, we would not be able to recommend to the IMF Board the continuation of the current programme because of the risks to the Indonesian economy." The IMF has provided a $43 billion (£31.3 billion) rescue package for Indonesia's failing economy, and its officials have warned that imposing the rigid measure could send interest rates soaring and that the consequences could be a worsening of the crisis.
However, the IMF has a record of opposing currency boards in countries where it has subsequently worked well. Currency boards have been set up in Hong Kong (1983), Argentina (1991), Estonia (1992), Lithuania (1994), Bosnia (1995) and Bulgaria (1997). The IMF strongly advised Estonia against setting up a currency board but the tiny Baltic nation went ahead and linked its currency with the German mark in a move regarded as the cornerstone of its economic success. The theory behind a currency board is that it obliges a country's central bank to have one dollar in reserve for every banknote valued at one dollar in the local currency. This creates expectations of long-term stability and attracts foreign investment. The more foreign investment there is, the more dollars come in and the more local currency can be put into circulation, fueling growth. But to succeed it requires wholehearted commitment and the IMF is clearly sceptical about the willingness of the Suharto government, with its ties to family-owned interests, to conduct a rigid fiscal policy or to keep the board in place if a recession occurred. Investors also need a sound banking system and transparency to monitor the currency board.
Indonesia's reserves are being drained through debt servicing and capital flight, one economist said, and it is difficult for a country like Indonesia with a substantial current account deficit to maintain a currency board. There is also the possibility that if a board is imposed, the market will launch a speculative attack on it if, as is likely, traders judge the system to be unsustainable. US President Bill Clinton evidently tried to discourage President Suharto from the idea in a 30-minute telephone call on Friday night. The call coincided with the leaking of the warning from Mr Camdessus that he would recommend the 182-nation organisation suspend its rescue effort to help Indonesia regain economic stability. Indonesia turned to the IMF for help last year after a crash in the rupiah exposed weaknesses in its financial sector. It is scheduled to disburse $3 billion to Indonesia in March, after a review of compliance with agreed conditions. The withdrawal of the rescue programme "would be a very unfortunate development, as it would shrink even further the reserve basis for the currency board and further undermine its very slim chance of success," Mr Camdessus was quoted as saying. German Deputy Finance Minister Mr Juergen Stark criticised the plan as premature and breaking the spirit of Indonesia's agreements with the IMF.
Without IMF money, Indonesia's economy and currency could weaken even further, pulling down regional currencies. Yesterday the rupiah, which six months ago was trading at 2,500 to the dollar, fell to over 10,000 on reports of the disagreement with the IMF. Editorial Comment, Page 15
