By Paul Blustein
Washington Post Staff Writer
Saturday, February 14, 1998; Page A01

The head of the International Monetary Fund wrote a private letter to Indonesia's President Suharto threatening to cut off bailout money because of a dispute over economic policy, raising the prospect that the international effort to stem Asia's financial crisis could come unglued.

President Clinton called Suharto last night to reinforce the IMF position in the dispute, administration officials said yesterday.

The confrontation between the Indonesian president and his would-be rescuers came as Indonesia's crisis deepened across both economic and political lines. The Indonesian rupiah, which had been climbing, plunged as much as 24 percent against the U.S. dollar. And the country suffered one of the worst outbreaks of violence since the onset of its economic troubles, with thousands of rioters in four towns looting and burning shops in protest over rising food prices. [Details, Page A25.]

The letter from IMF Managing Director Michel Camdessus, which was dated Wednesday and obtained by The Washington Post, came in response to evidence that Suharto is planning to change Indonesia's monetary system radically, adopting a Hong Kong-style "currency board" in which the value of the rupiah would be rigidly fixed against the dollar and the Indonesian authorities essentially would abandon control over interest rates. The IMF staff, backed by the U.S. Treasury and economic officials in other major countries, believes that Indonesia is at present incapable of credibly sustaining such a fixed exchange rate. Camdessus wrote that if Jakarta implemented the move anytime soon, he would urge the board of the 182-nation organization to suspend the $43 billion bailout of Indonesia's economy.

The imbroglio over the seemingly arcane currency issue threatens to plunge Indonesia -- and possibly its neighbors as well -- into a renewed bout of financial turmoil, analysts said.

The stock markets and currencies of Indonesia and several other ailing Asian countries, including South Korea, Thailand and Malaysia, have recovered some of their losses in recent weeks. The growing sense of stability raised hope in financial capitals and official circles that the worst of the region's financial problems may have passed following the commitment of more than $100 billion in loans from the IMF, World Bank and wealthy nations to the region.

But Indonesia, the world's fourth-most-populous country, is widely viewed by analysts and officials alike as the nation most likely to drag the region back into crisis. The rupiah, which fell as much as 80 percent from its value last summer, remains severely depressed, making imports hugely expensive -- so much so that many manufacturing companies cannot afford to import the raw materials they need.

And amid increased incidents of rioting in recent weeks, fears are rising that the country could become engulfed by social unrest and attacks by majority Muslims against the ethnic Chinese minority that might undermine stability throughout Asia.

Warning that Indonesia's problems could spread quickly, the governor of the country's central bank, Soedradjad Djiwandono, was quoted as saying in wire service reports yesterday that "contagion effects can be rapid, overwhelming and costly even to countries that have maintained consistently sound economic policies."

The rupiah's slide, to as low as 9,600 per dollar from 7,300 per dollar yesterday, drove other Southeast Asian currencies downward, including the Thai baht and the Malaysian ringgit, although the other currencies later rose as the rupiah recovered to about 8,600 per dollar.

Fueling the currency drops were reports that the clash between Suharto and the IMF was intensifying over the currency board issue, which aroused fears that Indonesia would lose international backing that it badly needs to restore investor confidence.

Suharto has made it clear that he favors a currency board plan championed by a Johns Hopkins University professor, Steve H. Hanke, to fix the exchange rate permanently at about 5,000 rupiah per dollar.

Under a currency board, a country's monetary authorities essentially pledge to put stability in the exchange rate above all other objectives, including economic growth, cheap credit and employment. They maintain a large reserve of dollars available to exchange the local currency at the fixed rate, and promise not to print more money without adding to their reserve of dollars.

Among the most successful examples of currency boards is Argentina's, which eliminated hyperinflation after implementing the approach in 1991, although the Buenos Aires regime has suffered through periods of very high interest rates and recession to maintain its fixed rate of one peso per dollar.

Contacted by phone in Jakarta where he arrived yesterday to meet with Suharto, Hanke blasted the Clinton administration and the IMF for trying to torpedo his idea. He noted that the rupiah had staged a powerful rally earlier this week as news emerged that a currency board might soon be introduced -- and that its partial recovery from Friday's tailspin came after he announced at a news conference that Suharto plans to press ahead with a board.

"We're completely puzzled as to why the Clinton administration and the IMF seems intent on destabilizing the currency and the country," Hanke said. "All the other currencies in the region are going up and down with the rupiah. So they [the administration and the IMF] are destabilizing the whole region. If this currency board doesn't go ahead, we're going to have total meltdown."

But in Washington, the IMF was issuing its strongest public criticism to date of Jakarta's proposed adoption of a currency board, and a special IMF representative, Prabhakar Narvekar, met with Suharto in an effort to dissuade him, according to wire service reports.

In a speech, Camdessus said he was of "the strong view" that the time for a fixed currency in Indonesia "has not yet come," because "a number of preconditions have to be satisfied." Among these, he said, was the need for Jakarta to obtain substantial reserves of dollars and strengthen the country's battered banking system. If Indonesia fixed its exchange rate without holding more dollars in reserve, it would invite speculators to attack the rupiah, the IMF believes, and Indonesia's cash-strapped banks might collapse if the authorities gave up their ability to print money.

Camdessus and Deputy Treasury Secretary Lawrence H. Summers declined to answer reporters' questions yesterday about whether the IMF would cut off funding to Indonesia.

In his letter, however, Camdessus wrote: "In the present circumstances . . . if a currency board proposal were adopted, we would not be able to recommend to the IMF Board the continuation of the present program because of the risks to the Indonesian economy. This would be a very unfortunate development, as it would shrink even further the reserve basis for the currency board and further undermine its very slim chances of success."

Camdessus said the IMF might favor a currency board for Indonesia once the necessary conditions are met. Hanke retorted that in his opinion, Indonesia already has met the necessary conditions, and he said he doesn't believe Suharto will capitulate to IMF pressure.