Indonesia’s Exchange-Rate Strategy and the Crisis of Policy Credibility -By Fransiscus Nanga Roka

Indonesia’s not the only one with a rupiah problem It has a credibility problem. If a currency habitually returns to stress despite repeated assurances, it is no longer just the business model or Fed tightening or seasonal dollar demand that has failed; as markets examine all this and ask whether they believe any such thing exists within the state beyond emergency defense.

For some time now Jakarta has responded to rupiah weakness with the usual basket of measures: spot market intervention, DNDF, offshore NDF also domestically; tighter foreign exchange purchase controls and more general liquidity management (and domestic instruments attract capital). These tools are important and can buy policymakers time in the short term by calming panics, preventing disorderly volatility. However, this time is only useful when it used to restore confidence. When it comes to Indonesia, time is all too often spent on optics rather than getting fundamentals fixed.

That is the real crisis. Reserves, restrictions and administrative tightening can help a government temporarily stabilize a currency. That only applies when the motivation for sustained capital flow is much stronger trust in fiscal discipline along with central bank independence, export earnings durability and overall policy environment. The ripples of high dirth dollars: Not that the dollars are short supply but rather confidence is.

This is the contradiction inherent in the current policy mix. BNI has, since then been aggressively intervening into spot as well as DNDF and offshore NDF markets while tightening local dollar purchase without underlying transactions.He is also supportive of reducing their USD dependency by implementing greater settlement in local currency. On its part, the government has highlighted exchange-rate stabilization and liquidity support measures while managing foreign-exchange supply and demand including incentives to retain export proceeds within their borders. On paper, this sounds comprehensive. However, it is still defensively looking in practice.

A strategy primarily designed to prevent depreciation is not equivalent to a plan capable of producing trend appreciation. This distinction is important, because achieving the kind of target usually debated in political circles rupiah can never go below Rp 12.000 per US dollar would not define incremental improvement as much as radical repricing on Indonesia’s macroeconomic credibility. The kind of action that this would involve needs large persistent capital inflows, a significantly better current-account position, much deeper domestic financial markets and rock-solid confidence in policy continuity in the face of pressure. You cant fake any of that with intervention theater.

The first condition for Indonesia really pushing the rupiah far stronger, is institutional credibility. At its own mandate, bank Indonesia also needs to achieve rupiah stability however that could be obtained only if the market believes that monetary policy is discipline and predictable. Credibility is clear communication, a consistent reaction function and insulation from politically expedient shortcuts. When markets suspect that exchange-rate management is being distorted for political ends, the currency turns into a confidence vote.

And the second requirement will be a much more determined push to lock export dollars in domestic, i.e. And you’ve been giving incentives to exporters so that they keep foreign-exchange earnings in Indonesia and that’s the right direction. However, a stronger rupiah likely would call for tougher measures like an even tighter export proceeds regime and more stringent forex traffic monitoring along with stronger incentives for conversion into rupees or longer onshore placement. To put it frankly, Indonesia cannot aspire to a heavyweight currency while too much commodity riches seep out of the country in a hurry.

The third would be a seriousness on fiscal matters. Markets do not award countries for simply speaking about nationalism or downward pressure or sovereignity, they reward states that seem governable. This translates into disciplined deficits, credible public spending execution of productive expenditure and a tax and spending profile that does not exacerbate fears over future monetization or profligate policy. The economy it loves is one which investors believe can make a success of the state; not at all, defiant sounding words.

Fourth, Indonesia will require much deeper financial markets. Analysts have called for more credible securities to mop up dollar liquidity and deepen the local currency and derivatives market. This is essential. The rupiah is also being easily pushed around because of its shallow market, as well rapidly drying up pools for abrupt capital flight and heavy reliance on hit or miss interventions by the central bank. Those have been playing, however what strength importing, and of course a quicker bond market broader hedging mechanisms or more active rupiah assets would now no longer increase their usual cream immediately away but tend to lessen the fragility.

Fifth, it would have to find a more ambitious path towards de-dollarization not for a slogan but for infrastructure. Starting with promotion of local-currency settlement and BI has taken public measures to decrease dependence on USD (US Dollar). However, serious de-dollarisation means broaden bilateral settlement channels, making corporations comfortable hedging in regional currencies and reducing the instinctive home bias on dollars being the final denotation of safety. So long as Indonesian firms and elites act like the dollar is the only adult in room, then politically defended but psychologicially distrusted rupiah will remain.

Sixth, Indonesia would be required to raise the even discipline of investments at an extraordinary speed. And after, more importantly perhaps, a stronger currency at Rp12,000 would “entail sustained foreign direct investment and portfolio inflows on levels consistent with long-term confidence (not speculative carry-trade opportunism)” It means legal certainty, regulatory consistency, contracts that can be enforced in a court of law (whether the other party lives across town or around the world), cleaner licensing and fewer times your political opponents enshrine their caprices into formal policy. In the end, currency strength is more than just a monetary consequence. It is a governance verdict.

This is where the criticism gets tricky Governments often defend the rupiah with allusions to patriotism, as if it were an instrument for defending their exchange rates themselves. It is not. Limiting dollar purchases, 24-hour intervention, or raising offshore activities can prevent panic and stabilize volatility but cannot replace confidence. If the markets sense broadening divergence between official confidence and basic policy coherence intervention becomes a fact less of strength than proclivity.

So what would be a serious strategy to strengthen the rupiah significantly:

a. Tight and credible monetary policy, a clear communications framework with no doubt about BI independence

b. Stricter and an implementable export-proceeds framework so commodity dollars remain onshore for longer as well supportive of domestic supply

c. More developed local currency and derivatives markets with instruments sufficiently attractive to absorb inflows without distortion

d. Fiscal restraint that reassures investors of Indonesia s growth immune to policy improvisation and credibility-eroding surprises

e. A proper overhaul of the investment climate with a basis in legal predictability and administration competence

f. Expanding local-currency settlement systems as a structural measure to lessen dollar dependence in trade and finance

Still, even the consensus target of Rp12,000 per dollar would still seem an inordinate goal and not a credible floor. Even that partial overperformance is not the more credible near-term objective; indeed, officials do not forecast such headlines but rather restoring a measure of trust like to bring the rupiah back toward fundamentals-justified levels. Indonesia dosent requires little red fictitious change rate. It needs a believable state.

Which is why the crisis of policy credibility matters more than that days ticker. In countries with sound institutions, weak currencies can be survived and recovered from. Richness spoiler alert: even weak credibility can eat reserves, restrict rules, bandy nationalism and watch the markets vote against it. The only sustainable way for the rupiah to strengthen is through Indonesia disengaging from its act of defending cut throat exchange rates while continuing to uphold credibility as a national asset.

Fransiscus Nanga Roka

Faculty of Law University 17 August 1945 Surabaya Indonesia