Financial Times August 29, 2001

East Timor rushes to build new monetary system

By Joe Leahy

Building a central bank from scratch in one of the world's poorest countries was never going to be easy.

But Fernando DePeralto, general manager of the Central Payments Office, East Timor's de facto monetary authority, manages to put a gloss on it.

"In some post-colonial African countries, significant restructuring of central banks was needed," says Mr DePeralto. "In many cases, this proved to be a far more difficult task than establishing a new central bank."

A former Jamaican central bank deputy governor, Mr DePeralto's task is to provide East Timor with a new currency and a workable monetary authority and payments system before it declares formal independence. This is expected to follow within less than a year of an election set for Thursday.

East Timor has never had a central bank. During Portugal's 400-year colonial rule, the escudo was the main currency. After Indonesia invaded East Timor in 1975, Jakarta introduced the rupiah and established a branch of its central bank to handle payments.

But when the Indonesian army pulled out of the territory following a United Nations-supervised independence vote in October 1999, the banks were burned and most of their senior staff fled back to Indonesia. "This resulted in a total cash economy," says Mr DePeralto.

In the ensuing vacuum, a brisk street trade emerged in rupiah and US and Australian dollars.

Today, visitors to Dili are harangued by illegal money traders, calculator in one hand, a fistful of currency in the other. Many of them claim they sold their water buffaloes or fields to raise capital for the business, although they are more likely part of an underground network.

"I make 50,000 rupiah ($5.70) a day or 100,000 on a good day," says Thomas, a trader, whose office is the footpath outside Dili's "Hello Mister" supermarket. Not bad in an economy where annual per capita income is estimated at US$325.

To clear things up, the United Nations Transitional Administration in East Timor, the body charged with ruling the territory until formal independence, in early 2000 settled on the US dollar as East Timor's official currency after consultation with local politicians.

Later last year, it established Mr DePeralto's office. Finding skilled hands to man the office has been a challenge. Today, about 30 of its 43 staff are East Timorese but a handover of the more senior positions could take at least three years, Mr DePeralto says.

The choice of the dollar followed a process of elimination. The Australian dollar and the rupiah were considered too volatile or too politically undesirable. The escudo was dismissed because it is about to be phased out. The euro might have been an option but it is not yet in full circulation.

The dollar was seen as a dependable hard currency. But its choice raised eyebrows in a territory where transactions below $1 are still common.

There were also concerns that the East Timorese would have difficulty recognising US coins. They come in irregular sizes - the five cent piece, for instance, is bigger than the dime. And their value is displayed in English wording rather than numerals.

Dollarisation also ties East Timor to US Federal Reserve monetary policy. This means its economy will have less flexibility to respond to fluctuations in the currencies of competitors.

However, Mr DePeralto said dollarisation promoted monetary discipline. "We have seen so many countries in the world where desirable economic decisions are postponed and instead the monetary base is expanded [by printing money], resulting in high interest rates and inflation," he said.

To speed up dollarisation, the UN has been repatriating rupiah to Indonesia and restricting imports of the currency. It is has imported nearly $10m in cash. Meanwhile, the UN and other international agencies are injecting about $2m a month directly and indirectly into the system.

Mr DePeralto's officials have also been educating people in the outlying districts on their new currency. The campaign seems to have had some success. Young people near Maubisse, a highland town south of Dili, recognise US coins and know their value in rupiah.

"It's better that we've changed to the dollar," said a farmer in the district. "If we used rupiah, it would be as if we were still being oppressed by Indonesia."

In Dili, rupiah deposits have shrunk by half to about $200,000 out of total banking system deposits of $30m, although the East Timorese may be keeping much more "under their beds".

However, the litmus test of dollarisation will be how quickly it is accepted throughout East Timor's $15m-a-year coffee export industry, says Chris Durman, general manager of ANZ East Timor, one of East Timor's two commercial banks.

While some farmers have reportedly accepted payment in dollars, others are still opting for rupiah even at poorer exchange rates.

"I think there will be two currencies in East Timor for quite some time," says Mr Durman.

"It's a bit like when the Indonesians replaced the escudo with the rupiah. There are still escudos from the old days turning up around the place today."

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