ADB warns RI over optimism on inflation

JAKARTA (JP): A senior economist at the Asian Development Bank (ADB) warned Indonesia on Tuesday the negative inflation rate posted in March did not signal a deflationary economy.

Sultan Hafeez Rahman said the central bank should keep the focus of its monetary policy on inflation, as prices might increase again in the run up to the June general election.

"A one month deflation rate does not necessarily mean a deflationary economy," he said at the release of the ADB's economic review on Indonesia.

He explained that monetary targets may exceed in the election year, causing a significant increase in prices in 1999.

The country posted a deflation rate of 0.18 percent in March, prompting Bank Indonesia (BI) officials to claim the economy was on a deflationary track. They also projected the inflation rate in the 1999/2000 fiscal year might be lower than the 17 percent target.

Coupled with the stabilizing exchange rate of the rupiah against the U.S. dollar, BI allowed domestic interest rates to continue falling faster than the market had anticipated.

Earlier, the International Monetary Fund (IMF) warned BI that interest rates should remain high until there was convincing evidence of improved confidence in the economy and a lower inflation rate.

The fund said there was still a considerable risk as the country struggled with its battered economy.

The ADB said in its 1999 Asian Development Outlook report that it would be very difficult for Indonesia to achieve its 17 percent inflation target in the 1999/2000 fiscal year.

But BI Governor Sjahril Sabirin downplayed both the IMF and ADB warnings, citing the lower inflation trend and stabilizing currency.

He said on Tuesday the central bank was optimistic the 17 percent inflation target could be reached following the negative inflation level in March.

He said if macroeconomic stability continued, there would be more room for the central bank to allow interest rates to continue to decline even below the 30 percent level.

The interest rate of the central bank benchmark one-month SBI promissory note is currently 35.58 percent.

ADB's Rahman acknowledged BI had superior knowledge about the country's monetary condition.

But he was convinced the central bank would push interest rates up again once the danger signs of inflation reappeared.

Rahman said the high interest rate environment may cause the government bank recapitalization program to exceed the estimated Rp 300 trillion target, because of the continuing negative interest rate spread problem suffered by the banking industry.

"It's too early to say, but if the negative spread problem persists, the cost will increase."

Rahman said the ongoing negative spread would continue to undermine the viability of the banking sector, which might prompt the government to close down more banks.

However, he also said the government bank restructuring program had been going well, despite a sluggish beginning.

He said firm implementation of economic reforms and a peaceful political transition would greatly contribute toward the restoration of investor confidence.

Rahman said the economic contraction was expected to bottom out in the latter half of 1999, with modest growth resuming in 2000.

He said Indonesia's export performance would improve this year, following improving economic conditions in the region., although exports traditionally shipped to the currently ailing economy of Japan would have to search for other markets.

He said resource-based exports and textiles would fare well.

"The prices of some commodities are expected to improve this year after plunging last year."

He said there was room for the rupiah to strengthen without hurting the country's export competitiveness, because the currency had taken such a tumble compared to other currencies in the region. (rei)