Bank Indonesia warned against interest rate cuts

JAKARTA (JP): Analysts have warned Bank Indonesia (BI) against joining the regional sentiment to cut interest rates, following the United States Federal Reserve's move to cut theirs, saying that it could risk an outflow of capital.

According to the analysts, Indonesia's economy is much too dependent on political and security issues which could offset any positive impact an interest rate cut might hold for the economy.

"In Indonesia, it's non-economic factors that drive the economy," Faisal Baasir, of the House of Representatives' Commission IX, told The Jakarta Post over the weekend.

While investment could remain low despite an interest rate cut, the move could also risk encouraging capital flight, he said.

Baasir suggested that the central bank be extra careful in studying the moves taken by other countries in response to the Federal Reserve (Fed)'s decision to cut interest rates.

The Fed last week cut its federal fund rate by one-half of a percentage point to 6.0 percent -- the biggest reduction in more than eight years -- in a bid to stave off a full blown recession in the U.S. economy.

Asian countries are likely to follow, with the Hong Kong Monetary Authority already cutting its base rate by half a percentage point to 7.5 percent.

Analysts have predicted that the Philippines and Australian central banks would follow suit, although the signals in other Asian countries remained unclear.

BI governor Sjahril Sabirin said earlier that he would watch the development of the rupiah's exchange rate to decide what to do with interest rates.

The central bank has kept the exchange rate high partly due to last year's strong inflation, to which a weak rupiah contributed

Baasir said that the Fed's interest rate cut would actually be a good opportunity for Indonesia to lower its rates, if it were not for the poor investment climate in this country.

However, he expected that the Fed's interest rate cut would speed up Indonesia's economic recovery by allowing a greater influx of foreign capital.

Economist Pande Raja Silalahi warned against an interest rate cut, saying that it might further discourage capital inflows.

Pande said that Indonesia could not simply follow the moves of other countries.

BI, he said, must carefully weigh the benefits of lowering interest rates to boost investment and the risk of losing capital.

A recently issued government regulation which hiked income tax on term deposit interest to 20 percent, was already hurting efforts to lure foreign capital, he said.

"If BI wants to cut its interest rates, then it must carefully search for the appropriate level where investing in bank savings accounts remains attractive to the public," Pande said.

An interest rate cut, he warned, should also not exceed the interest rate cuts of neighboring countries, thus reducing the higher margin of BI's rates.

"We must try to keep our margin level competitive against our neighbors," Pande said.

But even if interest rates were to be lowered, he went on, banks were still reluctant to channel loans.

Prevailing security concerns and legal uncertainties remained the biggest obstacles for banks in channeling their funds, Pande explained.

"The impact of lower interest rates is less significant than that of the present security disturbances," he said.

Some banks are also refraining from extending loans for fear that they could harm their capital adequacy ratios (CAR).

The CAR measures a bank's weighted average risks against its capital. This year, banks are required to raise their CAR to a minimum of eight percent from the present four percent.

Senior banker I Nyoman Moena said he was against the option of BI lowering the interest rate.

He said BI would be better advised to keep the current interest rate unchanged or to raise it.

According to him, Indonesia should seize the opportunity to lure in foreign capital by offering more attractive interest rates.

"We assume here that the investment flow to Asian countries will increase because of the Fed's decision," he said.

But he added that the present high interest rates continued to block the country's export growth, which had been hovering at $5 billion a month.

"It's a vicious circle," he said.

BI could either lower its interest rates and spur exports with the risk of capital flight, or hike rates to attract capital at the expense of export growth, he said.

To reduce dependence on foreign investment, he continued, Indonesia should foster the growth of agricultural-based exports.(bkm)