Indonesia Draws Fire for Plan to Link Currencies

Indonesia has become embroiled in a quarrel with U.S. and international monetary authorities over its plan to tie its currency to the American dollar--a move that outside officials warn could wreck its fledgling recovery effort.

The proposal--urged on President Suharto by his children, who would be among the prime beneficiaries--is being quietly opposed by the International Monetary Fund, the World Bank and many of the major industrial nations.

U.S. Treasury Secretary Robert E. Rubin warned Wednesday that Indonesia should concentrate on regaining credibility in financial markets before trying to set a fixed exchange rate.

Although Rubin did not say so, many strategists believe that the plan could undermine the $43-billion international rescue package for Indonesia worked out with the IMF last month. “The focus right now ought to be on . . . other issues that you have to work through,” Rubin said.

The proposal calls for Indonesia to replace its central bank with a “currency board” to set a fixed exchange rate between the rupiah and the U.S. dollar and do whatever it takes--including raising interest rates--to maintain it.

The decision is viewed as a test of whether Suharto is serious about breaking up the monopolies that have benefited his family--as his accord with the IMF promises--or if he will retain the crony-ridden economic system that got the nation into trouble.

Suharto appeared to give a green light to the proposal Monday, saying: “We must quickly fix the currency at a certain rate” so that Indonesian businesses can repay their debts more easily.

Indonesia’s finance minister, Mar’ie Muhammad, told parliament Wednesday that the government is preparing legislation establishing a currency board and plans to formally unveil it within a few days.

But the IMF said Wednesday that its staff is still “discussing” the plan with Indonesian authorities and that the talks are likely to be “going on for some time.”

The issue is important because how well Indonesia fares in putting its economic house in order could have an impact throughout the region. If Indonesia’s economy worsens and political unrest intensifies, analysts say, its problems could spread elsewhere in Asia.

Under the accord worked out with the IMF last month, Indonesia pledged to create an independent central bank that would guarantee the claims of depositors and shut down insolvent banks. That would have to be scrapped if a currency board were put in place.

Without the IMF’s approval, international officials say, a decision to create a currency board could jeopardize the entire $43-billion international rescue package.

Reports that the plan is being considered have strengthened the value of the rupiah on foreign-exchange markets. The Indonesian currency closed at 7,250 to the dollar in Asian markets Wednesday, up from 7,600 late Tuesday, when it rose 25% from the previous day’s level.

But IMF skepticism took its toll in early trading today as the rupiah lost as much as 7.6% to 7,850.

But this is still short of the level of between 5,000 and 6,000 that proponents of the currency board are seeking.

The plan is being touted by Steven Hanke, an economics professor at Johns Hopkins University in Baltimore, who outlined the program privately to Suharto last week at the invitation of the president’s daughter, Tutut.

Suharto, whose government has been under siege because of the collapse of its economy, is said to find the plan attractive because it offers him a “quick fix”--a way to bolster the value of the rupiah and presumably spur a return of capital into the country.

Not incidentally, it would also shore up the value of the vast assets owned by Suharto’s family and friends.

Hanke said Wednesday that the currency board would help Indonesian companies pay back billions of dollars that they borrowed when the rupiah was at 2,400 to the dollar. At the recent rate of 10,000 to the dollar, he said, “75% of the private sector is insolvent.”

But economists--including all of Suharto’s top economic advisors--warn that a currency board can work only if the government is prepared to back it by using up all its foreign reserves and raising interest rates sharply if necessary to maintain the currency’s value. That, in turn, could throw the economy into a deeper recession.

Hanke and others have pointed to the success of the Hong Kong currency board, but analysts say the former crown colony does not suffer from Indonesia’s credibility problems in the marketplace.

Mark Malloch Brown, a senior World Bank official, said creating a currency board would wreak havoc. “You’d throw the whole damned country out of work.”

An Indonesian economist agreed. “The country needs decisive action, but going against his advisors on the advice of his daughter doesn’t do much to add to his credibility” he said. “If this fails, the economy will go down the drain.”

Pine reported from Washington and Farley from Hong Kong.