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A devalued rupiah may have a lasting impact

Asiaweek - August 31, 1997

Tim Healy and Keith Loveard, Jakarta – These are perplexing times in Jakarta. First, the currency is safe; then it drops 20% against the U.S. dollar in just a few weeks. President Suharto speaks expansively about building a 95-km bridge over the Straits of Malacca connecting Sumatra and peninsular Malaysia. But rumors swirl about potential cutbacks in mega-projects such as the Indonesian national car, which is being built in South Korea by the president's son, Hutomo Mandala Putra (Tommy) Suharto. A senior cabinet minister talks about the need to dismantle one of the nation's most visible monopolies – control over wheat imports. Not long after, he admits that fellow ministers and the president himself may not support the idea.

A certain amount of confusion is always present in Indonesia's government – coordinating a burgeoning bureaucracy that serves 200 million people in the middle of a long – term economic expansion is not easy. But the latest economic difficulties highlight divisions that might otherwise have gone unnoticed. The debates range from narrow to broad: what impact will an inflated overnight lending rate, protection against currency attacks, have on long – term interest levels? How will an increasing gap between rich and poor affect presidential elections next year?

It was not long ago, as the Indonesian economy steamed ahead, that such questions seemed remote. Even when the Thai baht came under heavy pressure from speculators, Indonesia was seen to be safe. One reason: at 3.6% of GDP, the nation's current-account deficit last year was less than half of Thailand's. That perception began to change in early July. Having successfully beaten down the baht, speculators turned their attention further south. The Indonesian government responded by raising overnight lending rates and widening the band within which the rupiah traded before it would intervene. But by the middle of August, these measures were not enough. On Aug. 14, after spending $1.5 billion defending the rupiah, the government announced it would let its currency float – tantamount to devaluation.

Late evening is not part of Jakarta's normal business day. But on the night the currency was floated, office lights across the city burned into the small hours. Not everyone was thinking clearly. As one consultant put it: "People with degrees in accounting were adding up two and two wrong." By the time the sun came up, overnight money could be borrowed for a cool 100% interest rate, which strangled liquidity. Rates for one-month certificates of deposit from Bank Indonesia, soared from less than 12% to 30%.

In such numbers can the real significance of the nation's crisis be measured. High short-term rates mean Indonesia's many small banks are often paying more for funds than they receive back from borrowers. Last week, Bank Danamon, Indonesia's second-largest private bank, warned that if short-term rates remained at 30%, even larger banks would suffer. Some expect the high rates will be around for six months, though Gemala Group CEO Sofyan Wanandi says he expects they will ease by the end of September.

Mindful that all the uncertainty raises the possibility of bank runs, some banks have requested 24 hours notice for any withdrawals above $25,000 – in some cases, $5,000. And not just banks need to be concerned; 60% of Indonesia's $110 billion in external debt is owed by the private sector. Says one tycoon of businessmen once cocky about their successful overseas borrowing: "Now they're panicking trying to find ways to pay for it."

If nothing else, the currency crisis has focused Indonesian minds on their economic problems. Saleh Afiff, co-ordinating minister for Economics, Finance and Industry and Development Supervision, suggested the government treat the crisis as an opportunity to dismantle powerful monopolies. He said the first to go should be the Bureau of Logistics (Bulog), which controls wheat imports. But the words had barely left his lips before he spoke of potential obstacles: "There are ministers who disagree."

Afiff, normally a quiet presence in cabinet meetings, was following a tried and true tradition in recent Jakarta history: push reform and structural change when the economy is down. After the oil shock of the 1980s and again in the early part of this decade after the economy overheated, Indonesia deregulated. Speculation now is over whether the government will actually slow or cancel Suharto-family projects.

Only days before the rupiah crisis hit, Bank Internasional Indonesia joined a $690 million loan syndication for Tommy Suharto's Timor national car project. "Whether a project is commercially feasible or not is one question," said the bank's president-director, Indra Widjaja. "But you still have to consider the value of national pride." Suharto's second daughter, Siti Hediati Harijadi Prabowo, is expected to play a major role in building the proposed bridge to Malaysia. High-profile projects like Technology Minister B.J. Habibie's 100-seat jet could be jeopardized by a turn toward fiscal austerity. However, both Habibie and the president's son insist their pet plans are safe. "People are protecting their turf and jockeying for position," says Mohammad Sadli, a former minister and a respected economist.

But don't lose sight of the forest. The currency problem has ramifications for roughly 20-million middle class Indonesians, many of whom have only begun to realize dreams of a materially better life. Interest rates on home mortgages are now at 30%. "I've been too frightened to add up what it's going to cost me," says a geologist with oil monopoly Pertamina. Her family lives on a monthly budget of less than $1,000 and paid – even before the interest-rate rise – $284 a month for a small cottage on the outskirts of Jakarta. The economics aren't crushing, she admits, but a big interest increase would be an uncomfortable squeeze. "When I was a kid my family was poor but so was everyone else," she says. "Now the rich and poor are very far apart."

Such sentiment resonates loudly – especially considering that critical presidential elections are due in March. "We must make sure that if there have to be victims, they come from all sectors of society," says a government official. Speculators, at least, seem aware of the danger. In fact, it was the perception among traders that Indonesia was politically unstable that may have convinced them to attack the rupiah in the first place. "The positive economic fundamentals [in Indonesia] don't quite compensate for the political risks," says an analyst in Singapore.

Nevertheless, the seeds for a comeback may already be sown. Exporters should eventually benefit from the weaker rupiah, which makes their products more competitive. In the short run, however, SocGen-Crosby Securities economist Neil Saker says the nation is likely to see a slight worsening in its current account next year because of the increased cost of imports. Low-end manufacturers of footwear and textiles are in good competitive situations. On the other hand, high-tech manufacturers who must import newly expensive components from abroad are not likely to see the same benefit.

Two days after the de facto devaluation, just prior to Indonesia's Aug. 17 National Day, Suharto spoke about moderating expectations. That was just days before he said Indonesia would push ahead with plans to build the world's longest cable-span bridge. "Our determination to accelerate development must be accompanied by wisdom," he said. How his own wisdom will balance the costs and benefits of projects like his son's national car are likely to go a long way in determining whether the current currency crisis is remembered as merely a blip, a roadblock or a defining moment that opened the way to significant change.