Should Indonesia redenomindate its currency?

The monetary crisis that hit Southeast Asian Countries from July 1996 affected the development of the Indonesian economy. Apparently, the Indonesian economy was not able to face the global crisis engulfing the world. Indonesia’s economic crisis began with the weakening of the rupiah against the US dollar. On August 1st, 1997, the rupiah fell from 2,575 to 2,603 per dollar. In December 1997, the value of the rupiah against the US dollar fell to 5,000 per dollar. Soon, in March 1998, the rupiah continued to weaken and reached the lowest point, 16,000 per dollar. Adam (2000) argues that it seems Indonesia’s economic crisis could not be separated from a variety of conditions, namely (1) Indonesia foreign debt was very large. Although, the debt is not fully national debt, which means some parts are private debt, but it had a great effect on worsening the economic crisis . (2) Industrialization; the New Order government wanted to make Indonesia an industrialized country. The desire was not in accordance with real conditions of Indonesian society, which was predominantly agrarian with a very low level of education. (3) The centralized administration of the New Order government meant that all policies were determined from Jakarta. Therefore, the crucial role of local governments only served as an extension of the central government.

However, by the year of 2009 Indonesian economic development had become more stable than before. In fact, when most countries in the world experiencing negative economic growth, Indonesia’s GDP growth rate reached 4.5 percent (Indonesian Central Statistic Agency, 2010). This put Indonesia as one of the three best performing countries in economic terms the following year, in addition to China and India. Based on second Quarterly Indonesian Economic Growth Report in 2010, Indonesia’s high economic growth, supported by increased of exports, investment recovery, and maintained the level of public consumption (Indonesia Central Statistic Agency, 2010).

Based on the largest Indonesian online newspaper Kompas.com, in August 2010, due to economic growth and stability, the Central Bank of Indonesia planned to perform a redenomination of rupiah . Redenomination could be conducted in a situation in which macro-economic conditions, economic growth and inflation were stable and under control. Redenomination, in this case, means reducing digits (zeros) without reducing the value of those currencies. For example, the 1,000-rupiah bill would become 1 new rupiah in order to simplify the denomination (floating) currency into smaller fragments. With this simplification simultaneously carried out also on the prices of goods, this process would not change people’s purchasing power (Ioana, 2005).

Based on E. Borensztein and J.D. Gregorio (1999) research paper I can explained that in redenomination, the value of money for goods has not changed; only the way of writing the reference and floating currencies are changed and adjusted. This is different from devaluation, where the value of money for goods became smaller, because it cuts the value of the goods . Devaluation done in the event of very high inflation and macroeconomic conditions are not healthy. Some examples of redenomination: for one liter of petrol price currently at Rp. 4,500 per liter, if redenomination cut up to three digits (three zeros), then that must be paid about (new) Rp. 4.5 for 1 liter of petrol due to the price of one liter of petrol is also expressed the same in fractional units. While sanering, if there is sanering per thousand rupiah, then by Rp. 4.5 can only purchase 1/1000 or 0.001 liters of gasoline .

The principal aim of currency redenomination is to simplify fractions and to make it more efficient and comfortable in transactions (Oluba, 2008). Besides that, currency redenomination could make economic disparity within regional countries looks more equal and could overcome criticisms like that from Fox News (2008) , which claimed that Indonesia’s currency was among the world’s worst ten.

Therefore, this paper will argue that Indonesia should redenominate its currency because of its positive impact on society and its economic influences within the region.

Economic Impact of Redenomination

Redenomination might have a direct impact on the Indonesian economy. Mas (1995, p. 487) shows that during the transition period, redenomination is a very expensive and time consuming practice. Mas goes on to say that, at first, redenomination increases transaction time. However, despite the claims of like Mas who argue that, during the transition period, redenomination increases transaction time, Ahmad Bello (2007, p. 10) points out that in the accounting field, management will spent less time in evaluating and digitalizing financial data. Furthermore, while indeed it is possible that redenomination may cause changing prices in labels,menusand catalogs,, technical and operational problems arising from the use of figures with multiple zeros could soon be settled. This could help in developing the custom of using coins. Third, it is undeniable that changing the currency denomination may also necessitate change the balance sheets and accounting records. On the other hand, by using minimum number of zeros it would possibly be advantageous for businesses, as it would make things easier in terms of financial data input and reporting financial information and also business transaction process ( Ahmad Bello, 2007, p. 11).

However, Mas (1995, p. 487) mentions that currency redenomination has no direct impact on the economy or has little economic significance. The reason for this is that, as long as the value of the currency remains absolutely constant, and the ability to buy remains the same, the demand and supply services will not change means that there is no impact on macro and micro economic aspect; net investment, government spending, balance of payments and net exports will only suffer very little impact; and on household consumption level, the dissimilarity between pre and post redenomination currency will not be clearly seen as there is only minor psychological problems in related with customs. (Mosley, 2002; Zabuliene, 2005; Ncube, 2007; Lead Capital Limited, 2007)

Psychological Effect on Redenomination

“Psychological worries” may occur to Indonesian people that the currency may go back to multiple zeros after redenomination due to inflation. This is suggested by evidence that lower income levels “psychologically” suffer most of the effects of redenomination (Simge Tarhan, 2006). Evidence for this is that redenomination may generates artificial inflation in low price goods which the poor often buys. (Ahmad Bello, 2007, p. 14) . For example, in Nigeria, a N163 commodity in the present Naira becoming N1.63 may suddenly be charged at new N2 if the coins which would need to be used for the new transactions are not well-accepted, as it appears to be the case with the coins currently in circulation. However, Ahmad Bello (2007, p.6) believes that the psychological effect, which creates a sense of identity, is the most common reasons for a country engaging in currency redenomination. Similarly, Cohen (2004) posits that a national currency not only facilitates economic transactions but affects citizens’ identity and subsequently the legitimacy of the national government .

Lost of Value after Redenomination

Layna Mosley (2005, p. 10) mentioned that there were concerns about people starting to view their currencies as diminished in value, both economically and symbolically. Data to support this is that, Aluko (2007) provides list of many African and non-African countries whose citizens almost lost confidence in their currencies. According to him, as at July 2007, a US dollar ($1) exchanges 9270 cedi in Ghana, 9426 rupiah in Indonesia, 9861 franc/ariari in Madagascar, 10184 kip in Lao and 15921 dong in Vietnam. However, it has been argued that most common objective of redenomination is to ensure credibility (Layna Mosley, 2005, p. 6). Furthermore, certain governments adopt redenomination strategies in order to improve their monetary sovereignty and control tendency for currency substitution. On the grounds that, transition to single-digit inflation could restore the credibility of currency. In fact, research shows that enhanced credibility can improve government electoral fortunes, as citizens reward economic growth and macroeconomic discipline (Armijo, 1996; Stokes, 2002 in Mosley, 2005); and it can improve a government’s treatment as a borrower, as a location for private investment, and as a defender of an exchange rate in the eyes of global capital markets (Leblang, 2002; Jensen, 2005).

Redenomination As A Solution Strategy

Mosley (2005, p.1) argues that a few countries with high inflation level do not consider currency redenomination as a strategy. Indeed, some countries are very cautious about redenomination (Ishiekwene, 2007). For example, since the beginning year of 1997, South Korea’s won has fallen to 932 to a dollar , Hungary’s forint is 216, and Japan’s yen is 117, yet these countries put aside redenomination as their solution (Araki, 2001; Mosley, 2005). If there is going to be high inflation in the future, this redenomination program will only be an extra cost to the economy. However, currency redenomination is usually done when countries are experiencing hyper-inflationary pressures which have the effect of making its local currency unattractive (Ahmad Bello, 2007, p. 1). Simge Tarhan (2006) provides a clear case of hyper-inflation in Turkey where a bottle of drinking water cost 300,000 TL, a movie ticket 7,500,000 TL, Toyota Corolla: 32,900,000,000 TL (32 billion), and GDP in 2002: 273,463,167,795,000,000 TL (273 quadrillion) before the old Lira was redenominated by removing six zeros. Aluko (2007) cites the example of Zimbabwe that experienced years of inflation that hit 1200% a year. Determination in bringing inflation down to single digits permanently could be better comprehended. In some cases, if the timing was correct, redenomination could cap off high levels of inflation.

Redenomination As A Solution Mechanism

Ignacio Mas (1995) states that currency redenomination has been used as a solution mechanism throughout history. The reason for this is that redenomination often occurs after economic crises, as governments attempt to convince citizens and markets that hyperinflation is a thing of the past (Mosley, 2005, p. 1). According to Ishiekwene (2007), historical evidence suggests that redenomination had been very successful in an environment of macroeconomic stability, declining inflation, stable exchange rates, fiscal restraint and prudence and rational expectations of policy credibility.

Conclusion

Overall, I would recommend that Indonesia should redenominate its currency, since redenomination generates little impact on both macro and micro economic. In addition, redenomination affects rupiah appearance looks more attractive which increases citizen’s pride and confidence for their national identity, whereas, it could also influences the legitimacy of the national government. Furthermore, based on historical evidence, redenomination is very common strategy in the past to overcome hyperinflation and also to increase the credibility of currency in a stable macro and micro economic, declining inflation, exchange rates, fiscal restraint and prudence conditions. When the timing is perfect, redenomination could cap off low level value currency to reach its dignity.