Currency boards can sometimes work very effectively. The basic idea is that the board replaces the central bank, issuing domestic currency only when it is backed at a fixed exchange rate by a foreign currency such as the US dollar. If anybody in the private sector exports goods or brings in overseas investment they sell their dollars to the currency board in return for local currency, and vice versa. Local money supply can only increase if the country's foreign reserves increase. The effect is to prevent all political meddling in the domestic economy, which becomes wholly controlled by the markets.
Currency boards have a long history, the first being set up in Mauritius in 1849. From there they spread throughout the British colonies. Gibraltar and the Falklands still have one. Hong Kong revived its own version in 1983 after a currency crisis triggered by doubts about the handover; and Argentina introduced one in 1991 after a severe hyperinflation.
These two are generally deemed to have worked well, sustaining confidence and keeping inflation low. So why are there doubts about Indonesia's proposal? One obvious concern is that the fluctuations in interest rates that can result from a currency board require either a very strong banking system, which Indonesia does not have, or a genuine willingness to let banks fail. Even if the regime has such will, it is not clear that a swift and brutal round of failures is the best approach in a tottering economy.
But the real catch is that a currency board can not substitute for credibility in the broader sense. There are suspicions that President Suharto wants the board so that an exchange rate of around 5,000 rupiah to the dollar can be set. That would help his family-owned companies meet their foreign debts. A rate of 8,000, which would be more in the wider interests of the country, could prove financially ruinous to Mr Suharto. Currency boards are often a highly effective mechanism for restoring international confidence in an economy, but they cannot be expected to work for the greater good when operated by essentially corrupt and nepotistic regimes. The IMF should have no truck with Mr Suharto's plans.Reuse content