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World: Currency Boards Speed Up Stabilization

Washington, 16 February 1998 (RFE/RL) -- When Indonesian President Suharto suggested his country might adopt a currency board to help fight its financial crisis, the reaction from the global financial community -- and especially the IMF -- was swift and clear.

The Managing Director of the International Monetary Fund, Michel Camdessus said simply: the "moment has not yet come in Indonesia."

For a currency board to be successful, Camdessus told a conference in Washington Friday, a number of preconditions must be satisfied. If they are not, he said, the failure of the currency board would "completely undermine credibility in policymaking and severely damage the country's growth prospects."

The advice to Indonesia to wait awhile came "unanimously" from the IMF's Board of Executive Directors as well, said Camdessus, a reflection of the global scope of the belief.

But if a currency board idea is so bad for Indonesia, why was the IMF so adamant not a year ago that Bulgaria had to adopt a currency board to solve its financial crisis.

Camdessus said it's a matter of timing. The IMF has supported "several outstanding successes" with currency boards, he said, including in Estonia, Lithuania and Bulgaria.

The Director of the International Institute for Economics in Washington, C. Fred Bergsten, agrees. In countries like Argentina and Bulgaria, he told reporters last week, there had been a period of hyper inflation and the public was "ready to do anything" to get rid of the soaring inflation.

As importantly in Bulgaria's case, says the IMF, a currency board enhanced confidence in financial stability by symbolizing a break with the past, a past in which credit was all too easily available and often misused.

Not only was the currency board designed to quickly halt roaring inflation -- which it did in Bulgaria -- it also helped lower interest rates quickly. The combination of lowered inflation and interest rates contributes to a resumption of growth in the economy. That is already showing signs of bringing increased foreign investment into Bulgaria which, coupled with stepped up privatization, could give the economy a real boost of growth.

Estonia introduced a currency board in 1992 to coincide with the introduction of its new national currency as it departed from the ruble area. Lithuania adopted a currency board in 1994 with the objective of speeding up stabilization by strengthening monetary discipline.

In both the Baltic states, says the IMF, stabilization has been effective under the currency board and both have survived "significant" banking system problems as well.

The IMF says that to be effective longer term, currency boards must be reinforced by state budgets that do not require domestic financing on any significant scale, and they must have broad-based political and public support.

Bergsten says that is one of the real reasons a currency board is the "opposite" of what Indonesia needs. That country is wrecked by political instability, he says, especially because of the presidential elections next month and Suharto's choice for a vice presidential candidate -- and heir apparent -- is an official known to be strongly opposed to the main reforms demanded by the IMF.

"It's those political uncertainties that have been roiling the market, along with the government's failure to implement the IMF program faithfully," said Bergsten.

Suharto is using the currency board idea as a gimmick or "silver bullet" and nothing like that is going to solve the problem, he says. Prospects for a currency board succeeding in Indonesia are "very low," he said.

Business Week Magazine international finance commentator Kerry Capell calls it a "dubious" idea because the country is financially hamstrung and its political leadership lacks credibility.

Even worse, he writes, Suharto's real motive is to protect the financial interests of his family and friends. "If the government talks up the value of the rupiah (Indonesian currency), skeptics say, favored businesses and banks will be able to buy dollars at better than market rates. The fear is that once those companies pay off some foreign debts, any commitment to a currency board will evaporate."

Bergsten adds that setting a market-acceptable rate for pegging the rupiah to the dollar is impossible right now -- it has ranged from 3,000 to the dollar to as high as 19,000 to the dollar in recent weeks.

If a board set the currency's peg too high, demand for dollars would grow astronomically and local interest rates would soar as everyone cashed out their local currency. If the rate were too low, it would fuel inflation even further and make it unlikely that Indonesia could repay its $137 billion dollar foreign debt.

The IMF's Camdessus says Indonesia might be ready for a currency board once it has adequate foreign exchange reserves, has made more progress on rehabilitating its banking system, and most especially has advanced much further on corporate reform and debt. IMF officials say that day is a long way off.