T

he mandatory use of rupiah for domestic cash and non-cash transactions, scheduled for fully-fledged enforcement on Wednesday, is a sensible policy that will help curb onshore demand for dollars and ease the downward pressure on the rupiah.

However, the steady depreciation of the rupiah to the current level of Rp 13,300, the lowest since the height of Indonesia'€™s economic crisis in early 1998, has caused great concern not only among businesses but also within the fiscal authorities, who fear that the policy could threaten monetary, and eventually macroeconomic, stability.

The policy has been well designed by Bank Indonesia (BI) with a four-year transition period (after the enactment of the Currency Law in 2011) and a grandfather clause for transactions made before July 1.

The pragmatic policy also exempts a number of transactions, including international financial and commercial transactions, specified incomes and expenditures under the state budget, foreign currency savings and deposits at banks and many other categories of transaction that are allowed by the BI Law and the Investment Law.

Even more helpful in dealing with the fluctuating rupiah is that the BI regulation does not expressly prohibit a '€œratchet'€ mechanism from transactions, meaning that rupiah price quotations can change along with exchange rate movements. Local businesses, which are very exposed to foreign exchange risks, tend to use dollar price quotations as a hedging mechanism against the rupiah'€™s fluctuations.

Also encouraging is that the policy does not explicitly ban onshore banks and foreign bank branches from giving foreign currency loans as part of their business activity, as long as the loans are related to exports and other transactions allowed by law.

That said, given the rupiah'€™s current abysmal state, the full implementation of the policy is likely to increase foreign exchange risk for companies that traditionally set prices based on the US dollar or that have a significant component of their costs based on foreign currencies. Companies may be tempted to circumvent the BI rule that requires them to repatriate their export earnings to Indonesia.

The potentially major risks of this policy appear to have been the main factor that led Coordinating Economic Minister Sofyan Djalil to hazard accusations of interference in the politically independent BI, when he announced last Friday that BI was open to the possibility of revising the policy. He warned that if the full ban on onshore dollar transactions was implemented, the economy could be '€œdistorted'€.

Fully enforcing the policy, as required by the Currency Law, at a time of declining market confidence in the country'€™s economic outlook and in the government'€™s law-enforcement ability, could also trigger capital flight and raise unfounded suspicions that the government is looking to introduce several forms of capital control.