Interest rate debate<\/p>\n
State Minister of Research and Technology B.J. Habibie
\nreopened the debates last week on the adverse impact of high
\ninterest rates on the economy. This time, Habibie supported his
\ncriticisms against what he sees as persistently high interest
\nrates with the finding of a study made at his request by a
\nspecial team of aerospace engineers in the United States,
\nBritain, France, Germany and Japan. The essence of the study's
\nconclusion is that high bank interest rates are inimical to
\neconomic expansion.<\/p>\n
Elaborating on his argument, he pointed out that high interest
\nrates are discouraging investments and consequently stifling
\neconomic growth at the expense of job creation. Further down the
\nline, expensive credits are also causing inflationary pressures,
\neating into the lending revenues of banks and government receipts
\nfrom corporate income tax. Habibie, himself an aerospace
\nengineer, does not believe that a cut in bank interest rates
\nwould set off capital flight, because outgoing funds would return
\nthrough the capital market. He therefore suggested that the
\ncentral bank intervene to cut the high interest rates according
\nto a specified target zone.<\/p>\n
Habibie's views are, to a large extent, legitimate. Reducing
\ninterest rates is an essential ingredient for boosting economic
\ngrowth, creating more jobs. However, the economics of interest
\nrates is not that simple. It works through several different
\nmechanisms that vary in their effects at different times. As
\nregards the government intervention, as suggested by Habibie,
\nBank Indonesia's (central bank) monetary management always
\nincludes the interest rate among its policy tools. However,
\nconditions in Indonesia have not yet reached those found in many
\ndeveloped countries, which allow for interest rate management
\naccording to a set target zone.<\/p>\n
In so far as Indonesia is concerned, there are several factors
\nwhich influence credit interest rates. The most important among
\nthem are banking efficiency, the inflation rate and expectations
\nfor inflation, the depreciation of the rupiah against the
\nAmerican dollar and credit risks. The present conditions of those
\nfactors are not conducive for a significant cut in interest
\nrates.<\/p>\n
First, most major banks are still grappling with large sums in
\nproblem loans and are undergoing intensive consolidation to meet
\nprudential regulations. The inflation rate, though most likely to
\nbe checked at a single digit level, is estimated to exceed 7
\npercent this year. Given the open-capital account regime, the
\ngovernment cannot have an interest rate policy independent from
\nan exchange rate policy. As the government tries to maintain the
\nrupiah's depreciation at a maximum 5 percent a year, the interest
\nrates cannot be allowed at levels which the people do not believe
\nare sustainable within the management of the rupiah rate at the
\ndesired level.<\/p>\n
The absence of an adequate credit information system, obsolete
\ncommercial laws and a weak judicial system, which make the
\nexecution of credit securities extremely difficult, all combine
\nto make the credit risks in Indonesia much bigger than those in
\nother countries. Obviously, the credit risk is factored in the
\ninterest rates.<\/p>\n
Moreover, an easing in the monetary condition is not
\nwarranted, especially now, because all estimates predict a large
\ncurrent account deficit in the balance of payments, and the
\neconomy still tends to overheat. Low interest rates are feared to
\ncreate stronger pressures on the external balance because imports
\nmay increase faster than the government expects and the domestic
\nmarket will be made less attractive to both domestic savings and
\nforeign portfolio funds. Under the present condition, the impact
\nof an unsustainable current account deficit would be far more
\ndevastating than that of high interest rates.<\/p>\n
No wonder the central bank's intervention into the market over
\nthe past two years, either through open market operations or
\nprudential banking rules, has been designed mainly to tighten the
\nmonetary condition. For example, the latest measure, which was
\nannounced last September, will increase the minimum reserve
\nrequirement from 3 to 5 percent beginning in April. That will in
\nturn have a contractile impact on lending because banks will have
\nto put a larger amount of productive assets in the central bank
\nas idle money.<\/p>",
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