The Indonesian rupiah has been one of the strongest gainers against the US dollar this year, second only to the South Korean won.

Excess dollar liquidity has contributed to the Indonesian currency’s strength — so much so that the rupiah might well have stayed below Rp 8,500 to the dollar recently if it had not been halted by Bank Indonesia due to concerns it would harm the country’s competitiveness.

To say the least, the currency has come a long way from its record low — 16,950 to the dollar — during the Asian financial crisis. As of Thursday, it was sitting at 8,547 to the dollar.

Is a strong currency bad for Indonesia? Maybe not.

Exporters benefit the most from a weak currency, but exports account for only a quarter of the Indonesian economy, which is why the nation has not suffered as much as others from currency appreciation. Consumption accounts for more than half of Indonesia’s GDP.

A strong currency is good for the rest of country. Indonesia currently faces the risk of a worsening account deficit, mainly caused by excessive fuel subsidies. The price of non-subsidized fuel is as much as double that of subsidized fuel.

The gap, and Indonesia’s expenditure on subsidies, will only increase with unrest in the Middle East and the inability of Pertamina to increase oil production. The government has been considering reducing subsidies and preparing a direct cash transfer scheme to ease the burden on poorer people, who are considered the most vulnerable if subsidies are reduced.

This policy does not solve anything, but instead creates another problem: What should do people do after the money has been spent? Ask for more cash to be transferred?

A strong rupiah should not be considered a threat to the nation’s economic interests. The main reason the central bank keeps intervening in currency valuation is pressure from export-oriented companies.

Devaluation, such as in the case of the Chinese yuan, is the move of last resort to protect competitiveness.

Devaluation comes at a great price. The entire country must bear a burden to benefit the interests of a small group of stakeholders.

If the government keeps intervening to slow the rupiah’s appreciation, a vicious cycle will develop: as oil prices increase, the rupiah will stay weak against dollar, the government will pay more fuel subsidies, and eventually there will be less money spare for investments in the public good, such as infrastructure and education.

How would the government then raise more money? By issuing more sovereign debt. Even though Indonesia’s debt dropped from 28.8 percent in 2009 to 26.3 percent in 2010, the nominal amount is increasing.

The government is reluctant to reduce subsidies because of the risk of inflation. A reduction of subsidies is never a popular policy, and at this rate, it will not be implemented because of fears of destabilization and declines in political leaders’ approval ratings.

Given this situation, it is imperative that Bank Indonesia let the rupiah grow stronger and move as the free market dictates.

Currently, the United States and the European Union are faced with the risk of sovereign default while Japan has long suffered from a liquidity trap.

The three economies share common traits: low interest rates and slow economic growth. The low interest rate means banks can get cheap funds and increase their lending. Near-zero interest rates were put in place so people could borrow more and consume more, but it does not work because banks are reluctant to issue more loans to consumers.

The disparity in interest rates between major developed economies such as the United States , EU and Japan on one hand and developing countries such as Indonesia on the other is high enough that it will produce excess liquidity.

This situation will not last forever. Capital outflow will occur when the economy shows signs of recovery, however it may take years or decades — just like in Japan. This is the reason why government should not miss the opportunity to strengthen the rupiah.

It is true that when a currency is too strong, exports lose their competitiveness. However, making the currency stronger and easing pressure on the current account, the subsidy could be used to improve infrastructure and help Indonesia grow more than 6 percent a year.

As Nobel Prize-winning economist Merton Miller once said, money is associated with power and sovereignty. A government that devalues its own currency therefore devaluing itself.

Calvin Michel Sidjaja is a researcher for HD Asia Advisory in Jakarta. The opinions expressed are his own.

Source: The Jakarta Globe

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