South-Western College Publishing - Economics  
Rupiah Out of Control
Subject Exchange rates, Political risk
Topic International Finance
Key Words Exchange Rates, Investment, Economic Growth
News Story

Indonesian officials were considering some form of currency controls in order to stabilize the faltering rupiah, the national currency of Indonesia. The rupiah has lost 18 percent of its value in relation to the U.S. dollar since January, primarily because of political unrest. The head of the International Monetary Fund (IMF), Horst Köhlrt, met with Indonesia's President Abdurrahman Wahid and would not agree to controls. The IMF believes such controls would deter foreign investors and ultimately harm the economy. Without IMF support it is unlikely that Indonesia will pursue this policy.

In 1998, during the Asian economic crisis, Indonesia flirted with the idea of fixing the exchange rate of the rupiah. It backed off of this policy under intense pressure from the IMF. Indonesia has billions of dollars in loans from the Fund and only last week received approval for a loan in the amount of $372 million. These loans support debt-ridden banks and companies within Indonesia. Absent these loans, the economy would surely falter.

Currency controls have gained increased favor in Asia as a result of Malaysia's experience during its economic crisis. Malaysia tried to prevent its currency from leaving the country and imposed measures such as requiring exporters to repatriate and convert foreign exchange. Malaysia's economy had a dramatic recovery and many believe currency controls played a large part.

Many analysts believe that the cause of the decline of the rupiah is political, and not economic. Given the recent history of unrest, the value of the rupiah may represent the level of confidence of Indonesians in their government. Furthermore, Indonesia does not have the capacity to police currency flows into and out of the country and therefore its only impact would be to discourage foreign investment. The impact of a weak rupiah may not be as great as it was in 1998. Most companies that are affected by a depreciation of the rupiah have dollar denominated debt. Many of these firms are already bankrupt. The decline in the rupiah has boosted exports about 29 percent and this provides an economic stimulus to the economy.

(Updated July 1, 2000)

1. What are the primary determinants of the demand for rupiahs? What are the primary determinants of the supply?
2. If the rupiah is allowed to float, how is the exchange rate between dollars and rupiahs determined?
3. Why would Indonesia want to fix the exchange rate between the rupiah and the dollar? What are the consequences if they were allowed to do so?
Source Mark Landler, "I.M.F. Warns Indonesia Against Capital Controls," The New York Times, June 6, 2000.

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