Rupiah Redenomination: Are We Ready?
It’s a lot more complicated than just deleting a few zeros
By Tellisa Ramadhani
Wednesday, September 27, 2017
Focus group discussions on the plan were held between Bank Indonesia and the House of Representatives Commission XI on finance, the National Development Planning Board, banking and non-bank financial institutions on July 17.
The government feels that rupiah redenomination needs to be done as part of Indonesia’s membership of the G20 as it is believed that a smaller currency will raise the rupiah’s reputation.
But there are pros and cons on the matter, and many think the government has more important economic priorities to be managed before doing this. AmCham Indonesia spoke with Lana Soelistianingsih, Director, Chief Economist and Head of Research at Samuel Aset Manajemen.
AmCham Indonesia: Could you explain the redenomination proposal to us?
Lana Soelistianingsih: The idea can be understood because our currency has a big value. Whereas our neighbors such as Singapore, Malaysia and Thailand have smaller numbers currency. So this would impact efficiency in accounting and also in the banking system.
But to simplify, it is not merely by decreasing the number value of the currency. There will be implications. This simplification needs certain conditions, one of them being the inflation rate must be stable and low for a long period of time. The inflation rate of Singapore, Malaysia, and Thailand is about 2-3 percent, but ours still fluctuates. Now, it might help a bit with the government stopping the fuel subsidy so inflation is more controlled. There was something called the “demonstration effect,” when the government was only discussing raising the fuel price people thought it had already gone up, so when the fuel price actually goes up, people think it goes up even more, hence the snowball effect in the inflation rate.
But our inflation rate is affected by supply, including food stocks. We do not have adequate food supply, while our demand is getting greater. The past year has been good for our inflation rate. We still had an increase in the meat price last year, but the inflation rate is more controlled. But we need to be careful because inflation is controlled by government intervention, not because we have strong economic foundations. In the short term, we have to import agricultural produce because of our inability to serve local demand. The growth of the population and demand for more varied culinary products means our needs are greater. Our salt production, for example, is still people-based, so we are unable to mass-produce.
If the government releases its control of the factors affecting the inflation rate, what will happen? Meanwhile, the condition for redenomination is a stable inflation rate. Why? When the currency becomes much smaller, let’s say Rp1,000 becoming Rp1, and if the smaller currency or changes are not widely distributed in the market, then the sellers will tend to round the price to the bigger number. So, for example, the price at Rp1.2 could become Rp1.5 or Rp2, and the inflation is almost 50 percent. This will create bigger inflation pressure. For example, in the Aru Islands (Maluku), the inflation rate is high because of the unavailability of small change.
We have such a big territory, the question is: can the small change reach the remote and outer areas? This is what I’m worried about. Supposedly, the government could manage this with our naval forces distributing the money. But in reality, many people in remote areas have never even seen small change, and do the people in Jakarta even know the situation there?
So there needs to be socialization that no matter how small the currency is, it is still our money and reflects our sovereignty. So the implication I think is if the small currency is not openly accepted in trading transactions, what would happen is higher inflation. This would affect public purchasing power and the economy would slow down even more. Just like now, we feel purchasing power is slowing. That slow down does not mean it is definitely declining, but it just means it is not as good as what we had before.
So the government’s big homework is to stabilize the inflation rate. For food security, you were talking about the salt industry and how it is used for more than just food …
That is right. Even in the oil industry, when we want to do exploration, salt is needed. With all these industries relying on salt, there is a need for modernized salt processing that is able to accommodate demand on a big scale.
I mean the main produce, at least 75 percent of our consumption, should come from our own supply so we would be food safe. The government’s intervention to stabilize the inflation rate must have a limit. So I personally think, with the redenomination, if it is not a necessity it could be postponed until we are very certain that the inflation rate can be stable. Purchasing power comes from two factors, income and price. Yes, prices can be controlled by the government, but at the moment income is slowing down.
The transition will take a while. If I am not mistaken, 2018-2019 is the socialization time.
The problem is the government’s readiness to manage the issues as mentioned. In Jakarta, we have EDC machines almost everywhere so odd numbers won’t be an issue. With EDC machines widely available everywhere, this is beneficial for the banking industry as well, because of the fees.
There are countries that tried [redenomination] but it resulted in a higher inflation rate, so they went back to their initial currency.
What is the government’s main reason for wanting redenomination?
Because it feels the Indonesian currency with such big numbers cannot compare to Singapore’s currency. In the banking system, it is more costly with more numbers in the system. But even this cost is charged to customers. Why do we want to do a more costly change with redenomination if we can manage with the current one?
Japan and South Korea have big currencies, but they have no issues with it. Even with their deflation, they did not choose to redenominate to create inflation.
The government must be aware of the situation in the remote areas first. And I think the government needs to manage the issue of payment systems first, before redenomination. We know we still have issues with financial inclusion. The data varies from one institution to another. If people are used to it, redenomination will be much easier to implement.
What else can be done, after removing the fuel subsidy, so our economy can be stable?
Food supply is a sensitive issue and that supply is not actually owned by the government, but by the distributors. Even with the government being loud about not increasing prices, what can they do when the supply is not managed by them?
There is a problem in the upstream. So, for example, the farmers want to start planting but have no capital, and so they ask loan sharks. Banks cannot give loans because of bad collateral. These loan sharks can ask for the produce to go through them, which is then sold to the debt collectors. The collector is not the government and they can be the one controlling the produce and price. It is a really complicated issue and needs to be taken care of. Maybe there needs to be a change in the distribution chain. The upstream definitely needs improvement. Banks need to be more lenient in giving loans to farmers.
In the short term, the government has no other choice but to import. But for the long term, they need to prepare productive land for agriculture needs. Food supply is the most sensitive factor for inflation rate stability.
The government is also cutting the electricity subsidy, which many people think is one of the factors in slowing purchase power.
Cutting the subsidy is actually good. So the people do not keep relying on the government. But the problem is, the government’s stock is inadequate, and in certain commodities, subsidies are still needed, for example with electricity.
Have associations been giving advice to the government on redenomination?
I think they hosted FGDs [focus group discussions] involving stakeholders and the research from Bank Indonesia is actually really good. But, as mentioned, the government might overlook some issues. I think if those issues are mentioned earlier, there will not be a problem with the inflation rate.
Would redenomination affect foreign investment in Indonesia?
I don’t think so. But if the effectiveness of redenomination is doubted, then it is possible. But I think this kind of thing will not happen immediately, because they need to see how the implementation will be done. If this happens, maybe in 2020 the effects will be visible.