The momentum to remove fuel subsidies

The momentum to remove fuel subsidies

Wednesday, April 04, 2012

The Jakarta Post

If Bank Indonesia (BI) cuts three zeros in the Indonesian rupiah, the nation’s consumers would lose confidence in our currency. For many old enough to remember, it would be the sanering or slashing of the currency’s value of 1959 all over again.

If we handle the redenomination quickly, these pains can be minimized. But for the redenomination to work, BI must also expedite the redenomination to maximize the momentum gained from the potential elimination of fuel subsidy.

The Law on Rupiah Redenomination is being debated by the central bank, the Finance Ministry and the House of Representatives, and is scheduled for completion by the end of the year.

For the past several months, BI has been involved in a media campaign to promote the concept of its redenomination policy. This rigorous effort is to ensure that the launch of the ambitious program goes unhindered.

Should we fear the loss of zeros, or should we focus on a basic understanding of what the redenomination policy is? On multiple occasions, BI has emphasized the difference between the redenomination policy and that of the sanering in 1959.

Sanering is a term taken from Dutch that refers to financial devaluation entailing a reduction in the value of the currency compared to the goods and services produced. But many Indonesians may not understand the distinction between sanering and redenomination.

The redenomination policy involves a change in the value of the rupiah, from thousands into just ones. What happens to the economy when such a policy goes into effect? The change would implicate a lower nominal GDP value because of the change in the rupiah, but the real GDP does not change. The real goods and services produced by the economy remain the same.

The redenomination policy is separated into four stages, namely preparation, dual label procedures, and the removal of old currency. The fourth stage involves finalization to ensure that none of the old currency remains in the financial system. The program is set to span from 2011 to 2022, which is a substantially long period of time for the policy’s implementation.

The central bank during the dual label stage, will issue new rupiah notes that show three slightly faded zeros. A new bill, such as the Rp 100,000 bill, will more likely be seen as Rp 100 because of the three faded zeros written on the bill. The old rupiah note remains on the market before the central bank withdraws it in the third stage.

It is the long, drawn-out process that remains the biggest weakness of this policy. The redenomination policy is not a new policy. Turkey introduced a similar measure in 2005, eliminating six zeroes from the old Lira.

The efficiency of the redenomination is what differentiates Indonesia. In Turkey’s case, the elimination of six zeroes occurred over one year. People were encouraged to exchange their old currency within a year’s time. Some would argue that Indonesia’s large population would require a longer implementation period, but I would argue otherwise. With eleven years of implementation, the amount of resources devoted to preserve this policy would overcome the qualitative good that it projects.

Why do we need the redenomination policy? The central bank can choose redenomination for political and economic reasons. The most common economic reason is hyperinflation or extremely high inflation that has made the existing currency almost worthless. Indonesia has encountered high inflation, especially during the 1997 Asian Financial Crisis, and is expected to face inflationary pressures as a result of the removal of fuel subsidies over a span of a few years’ time. Each time the government removes a portion of the subsidy, ripple effects cause price increases in distribution and in the prices of normal goods that depend on transportation costs. This effect is very crucial given Indonesia’s geography.

Recent tension in the Middle East has caused an increase in world oil prices. With subsidies in Indonesia reaching a staggering Rp 137.4 trillion, mainly for fuel, the government has been forced to consider removing part of the fuel subsidy, causing price adjustments. Arguably, unless the fuel subsidy is eliminated, the effort to redenominate the rupiah will be in vain.

From a political standpoint, the redenomination policy will create greater confidence in the Indonesian rupiah and efficiency in managing its bank notes.

Redenomination is not the sole answer to the problems of public finance in Indonesia. The central bank should focus on its contradictory monetary policy as a way to reduce the money supply and as a means of attaining better appreciation for the rupiah.

The recent introduction of government bonds (SBI) has enabled the government to intervene monetarily in the economy. Better monetary policy should allow us to avoid mourning the losses of zeros in the Indonesian rupiah in the future.

The writer is currently pursuing Master of Public Policy at Harvard University, John F. Kennedy School of Government, Cambridge, Massachusetts, US.

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