Banking developments in 1996 and policy directions for 1997
Banking developments in 1996 and policy directions for 1997
The following article is an excerpt from a paper presented by
Bank Indonesia Governor J. Soedradjad Djiwandono at an annual
bankers' meeting on Jan. 9. This is the second of two articles.
JAKARTA: The following are several key issues faced by our
economy and banking system this year and the years to come.
First, as the domestic economy become more integrated into the
world economy, consequently our economy will become more
sensitive to any disruption in the world economy. Any event,
either economic or non economic by origin, whether in Indonesia
or other countries, will impact the financial sector and hence
also economic stability. It is important to bear in mind the
increasing risk of contagion effect, namely that one nation's
economic disruption, can quickly spread out to other countries
even though their economic fundamentals are strong. Indonesia,
Thailand, Hong Kong and Malaysia experienced this contagion
effect in the wake of the Mexican crisis.
Furthermore, Indonesia's financial markets were also shocked
by the issue concerning the President's health in early July 1996
as well as the outbreak of the July 27 riots. We are fortunate
that none of these have produced major disturbances in the
economy. Our economic fundamentals are definitely strong, but
neither can we rule out the possibility of even stronger shocks,
and therefore we must remain cautious.
Second, inflation is still running high. Although this year's
inflation is well under control, the average inflation rate
during this current Repelita VI has reached 8.2 percent, far
above the target established at the beginning of the Repelita. We
must remind ourselves that the inflation target is 5 percent,
this does not imply targeting inflation only within the single-
digit range.
Therefore, despite lower inflation over the past two years,
more efforts need to be done to bring inflation down to its
target. This is especially important given that our inflation
rate is relatively high, compared to those of neighboring
countries and our major trading partners.
The high inflation is borne disproportionately by fixed income
and low income groups in society. In addition, if our future
efforts to bring down inflation succeed in reducing expected
inflation, there will be greater possibilities towards lower
nominal interest rates. In turn, this will relieve the interest
burden borne by the business entities while the associated
reduction in the interest rate differential will be less
attractive to capital inflows and consequently relieve upward
pressures on the value of the rupiah. All these will strengthen
the competitiveness of our exports on the international market.
Third, non-oil/gas export growth is still weak and on the
decline, making its average below the Repelita VI target.
Although we know that slower export growth is common feature
across Asia, we still have to improve our national
competitiveness, which deteriorated during the past year.
Surveys by some international agencies downgraded Indonesia's
competitiveness, which was previously already at the lower part
of the scale, to an even lower rank. The survey findings should
alarm us to improve our competitiveness as a nation.
The government and the private sector must therefore reduce or
even eliminate high costs economy while also diversifying export
commodities. At this point, I should mention that the growing
integration of Indonesia's financial sector into international
financial markets gives us less flexibilities in using exchange
rate policy to promote the competitiveness of non-oil/gas
exports.
Fourth, there is an anxiety regarding capital inflows. Given
its saving-investment gap and current account deficit as a
developing country, Indonesia needs foreign funds. Nevertheless,
we also recognize that the more domestic investment financed by
foreign sources, the greater the potential risks for the national
economy.
These risks become particularly acute when the capital inflows
take form of short term and speculative funds. We must therefore
endeavor to attract more long term capital inflows, by
consistently improving the fundamentals of the economy. We have
to ensure that the allocation is used as efficiently as possible
for productive activities.
Fifth concerns the readiness of our banking system for the
coming era of ASEAN free trade. This era will be marked by faster
growth in non-credit banking services, and therefore Indonesian
banks need to do their utmost to improve competitive advantage in
this area. In this regard, our banks will make substantial
improvement in their competitiveness if they are able to overcome
non-performing loans and we resolve the problem of troubled banks
that still afflicts the banking system. This includes, the
efforts to improve in the quality of human resources will also
enhance.
Sixth, banks are being encouraged to employ risk management
more effectively and efficiently. Through the implementation of
self-regulatory banking. Bank Indonesia is assessing various
regulations concerning bank appraisal, particularly on managerial
aspect with more weight to management quality and performance.
The assessment of bank management encompasses two key areas:
general management and risk management. Analysis of general
management is aimed at assessing the quality of bank management
covering strategy, structures, systems, human resources,
leadership, and corporate culture. All of these are essential to
bank performance. Analysis of risk management is aimed at finding
the extent to which the bank has hedged itself against risk
bearing activities. Important aspects in this area include credit
risk, liquidity risk, and market risk.
In 1997, the Indonesian economy appears set to perform
reasonably well as during the past years. Economic growth is
expected to remain above the targeted average for Repelita VI.
Although domestic demand is showing signs of abating, it will
remain an important element driving economic growth. Investment
is expected to be buoyant, particularly when many of last year's
investment approvals move forward to implementation. Rising
public incomes will lead to higher public consumption.
The improvement in the world economy will also be favorable to
the national economy in 1997. Stronger economic performance is
expected from Indonesia's major trading partners, particularly
Japan and the United States.
The expansion of economic activity in these countries, coupled
with increased transparency in international trading regulations,
are expected to foster greater volume of world trade and help
strengthen prices for both primary commodities and manufactured
products. These developments provide Indonesia with opportunities
to boost the export. Hence, year 1997 is expected to record a
better balance between domestic and foreign demand.
Given the outlook of continued strong domestic demand, we must
remain vigilant of upward pressures on prices. For this reason,
the government will maintain a prudent fiscal and monetary policy
so as to keep domestic demand in check. At the same time, the
Government will continue the efforts to eliminate bottlenecks in
the supply side by expanding domestic production capacity through
productive investment and expediting the production and
distribution of goods. These measures are expected to contribute
to a lower level of inflation in 1997 than in 1996, bringing it
closer to the target for Repelita VI.
The rising current account deficit in recent years demands
continued vigilance. The deficit projection for 1997/1998 is
US$9.8 billion, equivalent to about 4 percent of the GDP. The
main factor responsible for the rising current account deficit
includes high non-oil/gas imports growth of 13,5 percent while
various internal and external constraints continue to handicap
non-oil/gas exports. As I pointed out earlier, non-oil/gas
exports are hampered domestically by poor efficiency in
production and marketing, while competition in international
trade is heightening force. Several countries in Asia,
particularly China, India, and Vietnam, now compete closely with
Indonesia on the international market. These countries have
demonstrated serious, consistent measures to improve their export
performance. For these reasons, there is no room for complacency
and we must promote non-oil/gas exports with a minimum growth
target of 14 percent in 1997/98.
At the same time, strong economic fundamentals and a conducive
investment climate have encouraged strong capital inflows, and
thus the overall balance may again record a surplus. Therefore,
official reserves are expected to reach over US$20 billion,
sufficient to finance non-oil/gas imports for about 4.5 months.
In light of this economic forecast and the various issues that
I have presented, the monetary authority believes that prudent
economic policies in the macro, micro and sectoral level are
still necessary to ensure the sustainability of national
development. Economic policy formulation will continue to be
carefully planned and coordinated, thus ensuring that Indonesia's
economic fundamentals remain strong.
In 1997, monetary policy will continue to be focused on the
efforts to strengthen both internal and external macro-economic
stability. For this purpose, an indicative target of 17 percent
has been set for the expansion of claims on business sector
during 1997, and this is expected to bring M2 growth down to 18
percent. Monetary policy stance is aimed at maintaining the level
of domestic interest rates capable of maintaining internal and
external equilibrium.
Real interest rates are expected to ensure that the growth of
domestic demand, is consistent with the effort to bring down
inflation and the current account deficit. Efforts will also be
carried out to reduce the gap between offshore and domestic
interest rates to a reasonable level that does not attract large
inflows of short term which is speculative in nature.
This will help control the monetary expansion generated by
capital inflows, particularly from short term funds attracted
mainly by the relatively high differential between domestic and
international interest rates. Along with this, the rupiah
exchange rate will be maintained at a realistic level without
anti-export bias.
The government will continue to strengthen the balance of
payments by maintaining sustainable current account deficit,
applying prudent debt management and maintaining adequate foreign
reserves. Prudent debt management includes the efforts to control
private sector borrowings, particularly those incurred by banks
and state enterprises, through improved management by the
Commercial Offshore Loan Team.
With the ongoing process of globalization of the financial
sector, the business community has more opportunity than ever
before to benefit from a wide diversity of offshore financing. In
this area, the government will continue to place high priority on
equity financing and long term foreign loans.
To support the efforts in the monetary sector, the government
is also adopting a prudent fiscal policy through a continued
stance of balanced, dynamic budget policy. If necessary, the
government will not hesitate to apply a fiscal policy that will
generate a surplus. At this point, I should emphasize the strong
coordination maintained between fiscal and monetary policy has
contributed enormously to a more effective monetary control. In
light of this achievement, the close cooperation between the
monetary and fiscal authorities and other competent agencies will
continue to be fostered.
These macro-economic policies represent a minimum or necessary
condition for macroeconomic stability that is essential for
sustainable development. However, macroeconomic policies alone
are not adequate. All of this must also be supported at the micro
level. Monetary (macro) policy can only be effective if supported
by strong, solid financial and banking industry (micro) and a
secure, efficient payments system.
In recent years, I have repeatedly stressed the importance of
integration in the implementation of these macro, micro, and
sectoral policies. The importance of these macro-micro policies
were also emphasized by key speakers at the seminar on
"Macroeconomic Issues Facing ASEAN Countries" held jointly by
Bank Indonesia and the IMF in early November 1996.
In this regard, banking policies will continue to focus on the
development of a sound, competitive banking industry. This is
essential because banks assume a special function in the process
of creating money supply and maintaining the stability of the
national financial system, and therefore play a pivotal role in
the implementation of monetary policy. A financial sector with
sound, efficient institutions is vital to the implementation of
monetary policy and the operation of the national payments
system. Both are important elements to support development.
A very recent IMF study found that 130 of the 180 member
countries in the IMF have experienced banking problems, with
various stage that have adversely impacted the effectiveness of
monetary policy. This finding emphasizes the need for a sound and
competitive banking industry in the economy. Policy measures
adopted in this direction are expected to lead to the creation of
a financial system capable of supporting and promoting the
activities of the real sector. The creation of such a financial
system is crucial to sustainable economic growth.
In this regard, Bank Indonesia will consistently pursue
banking policies aimed at creating a sound, secure banking
industry that will support effective implementation of monetary
policy.
It is within this framework that various measures will be
continued with the objective of building a strong, secure, and
competitive banking system. These measures include the settlement
of problem loans and problem banks, as well as more effective and
efficient risk management. Also important are mergers and
consolidation carried out as part of the restructuring process to
create a stronger banking industry. In the case of rural banks, a
review will be conducted on the status and supervision, given
that the characteristics of these financial institutions differ
from those of commercial banks. Furthermore, the various
constraints faced in writing off bad debts sought to be solved.
This is important, given that some banks have now accumulated
adequate reserves for write-off.
For this purpose, closer coordination is needed with related
agencies, and the Draft Government Regulation on Banking Secrecy
needs to be completed within the near future. Additionally, the
introduction of the government regulation on liquidation is
expected to facilitate solutions for problem banks, particularly
through consortium rescue packages or through acquisitions by
other banks.
In a further move to improve the efficiency and effectiveness
of risk management, the program undertaken since 1995 for the
application of self-regulatory banking principles will be
continued while other improvements will be undertaken in
management quality, human resources and technological
infrastructure. In another measure aimed at improving risk
management, the Criteria of Reprehensible Acts Precluding Persons
from Holding Position as Bank Shareholders or Bank Management
will be intensified, along with a more intensive implementation
of Cease and Desist Orders.
To encourage the development of a banking system that is
competitive both internally and externally, the process of
restructuring will be carried out further until a more optimum
banking structure is achieved in a way that is capable to support
overall development. For this purpose, greater incentives will be
offered for banks to merge and consolidate.
Concerning the payments system, I would like to mention that
Bank Indonesia has prepared a blue print to serve as a reference
for the future development of an efficient, secure, and reliable
national payments system. Many central banks are now devoting
greater attention to the importance of a payments system based on
these consideration.
First, the payments system supports the creation of a more
efficient financial sector while improving the effectiveness of
monetary and banking policies.
Second, the payments system involves a considerable potential
risk that may affect overall economic stability. This blue print
details various matters related to institutional organization,
policies, legal provisions, infrastructure, systems, and
procedures, as well as some programs to be developed
progressively in the short and long term.
Bank Indonesia will soon introduce an electronic clearing
system in Jakarta as part of the short term program for the
development of national payments system. A study is also under
way for a Retail Payments System to be developed soon. Another
development program still under intensive study is related to
Electronic Funds Transfer, to serve as part of a High Value
Payments Systems.
As we all know, main elements in the operation of a national
payments system are banks. Therefore at this opportunity, I would
like to urge banks to play more active role in the development of
this national payments system. The success of the system will
tremendously benefit not only the growth of the national economy,
but also the operations of the banking community itself.