BI cuts interest rate to a new historic low 8.06%

Dadan Wijaksana, The Jakarta Post, Jakarta

Bank Indonesia cut its benchmark interest rate to 8.06 percent during the weekly auction of its SBI promissory notes on Wednesday, from an already all-time low of 8.24 percent last week, defying analysts expectation that the rate's declining trend would soon come to a halt.

The rate cut, indicates the central bank's determination to cautiously maintain the two-year declining trend in the interest rate.

The move should provide more leeway for the banking sector to follow suit, by lowering rates for lending to the corporate sector and make it more affordable for businesses. Theoretically, this would spur productive activities in the corporate sector and thus accelerate economic growth.

Bank Indonesia has attributed the rate decline to the stable rupiah and easing inflation. Throughout 2003, the rupiah strengthened at an average of Rp 8,577 per dollar while annual inflation eased at 5.06 percent -- the lowest in the past four years.

But, with the general election looming, many are doubtful over the continuity of such a declining trend in the interest rate, including Bank Mandiri.

In its economic outlook report issued on Wednesday, the country's largest bank expected the one-month SBI rate to go up this year, as the general election would likely create pressure on the rupiah and ignite inflation.

The benchmark rate might start rising in March or May, all the way until the end of the year, at a range of 8.9-9.5 percent, the bank's chief economist Martin Panggabean said.

"This is based on the assumption that the rupiah will hover at an average of 8,800 (per dollar) and (annual) inflation at 6.8 percent," Martin said.

Both are higher than targeted in the 2004 state budget. While the rupiah's average is predicted at 8,600 against the U.S. dollar, inflation is set at 6.5 percent.

Martin said that during the elections period, the political atmosphere would heat up.

Although investors would not necessarily dump the rupiah, most would apply a "wait and see" attitude, which eventually would hamper the performance of the local unit, which was one of best performing currencies in Asia last year.

A weaker rupiah would put upward pressure on the prices of imported goods.

Meanwhile, trillions of rupiah provided by 24 parties to support their campaign activities would increase money in circulation -- both serve as major inflationary pressure.

The reverse in the current declining trend of the Bank Indonesia rate, would consequently make it harder for the banking sector to boost its lending portfolio to the corporate sector, as banks would very likely up their lending rates as well.

Even last year, when the benchmark rate from Bank Indonesia was sharply slashed, banks remained reluctant to lower their lending rates to the private sector.

Against this background, while private investment remained scarce, Martin expected the economy this year would expand by only 4.3 percent, lower than the government's target of 4.8 percent.

"That's an optimistic prediction. The worst scenario is that the economy would grow by 4.1 percent," he added.