BI interest rate move may be prelude to CBS

BI interest rate move may be prelude to CBS

JAKARTA (JP): Bank Indonesia's decision to peg domestic time
deposit interest rates to its short-term promisory note (SBI)
rates could be a prelude to an introduction of the controversial
currency board system (CBS), an analyst said yesterday.

Lin Che Wei, a banking analyst with SocGen Crosby Securities
Indonesia, said the new rate formula might indicate that the
government was serious about setting up a currency board to peg
the rupiah to a foreign currency at a fixed exchange rate.

"I think the new policy is in anticipation of implementing the
CBS in the near future," he told The Jakarta Post.

Lin said that by establishing a ceiling on interest rates, the
central bank was providing a cheaper way for domestic banks to
improve liquidity, or their loan to deposit ratio, before the
implementation of a currency board.

He said the average loan to deposit ratio of domestic banks
surpassed the favorable 110 percent to 115 percent level and was
between 130 percent and 140 percent due to massive public
withdrawal of deposits following the liquidation of 16 banks in
November.

The central bank has reportedly injected a total of Rp 60
trillion (US$6 billion) into the banking system to help
commercial banks cope with liquidity problems.

Lin explained that if interest rates remained at their
current, uncontrollable high rates, banks would find it too
costly to secure liquidity before an implementation of the CBS.

A CBS would eliminate the central bank's role as the lender of
the last resort.

Bank Indonesia (BI) introduced a new formula Monday in
calculating interest rates by placing a ceiling for commercial
bank rupiah time deposit rates at 1.25 times the SBI rate.

BI acknowledged that the previous system, which pegged the
rupiah deposit at 1.25 times the Jakarta interbank offered rate
(Jibor), had failed to prevent a recent uncontrollable surge in
interest rates following the government's January measure to
guarantee all domestic banks and the expectation of high
inflation this year.

Another analyst, who declined to be named, shared Lin's views,
adding that many in the market were also anticipating the
introduction of a currency board, which is expected to peg the
rupiah at 5,000 or 5,500 to the U.S. dollar.

He pointed out that many people were keeping money in short-
term instruments so they could buy dollars at the cheaper level
should the CBS come into effect.

Since August, the rupiah has been on a roller coaster ride,
plunging to its lowest level of 17,000 against the dollar in
January compared to its pre-crisis level of 2,450 in July.

The rupiah closed yesterday at 10,600 to the dollar.

The government's CBS plan has become a major source of
contention in the increasingly tense relationship between
Indonesia and the International Monetary Fund (IMF), which,
together with other donor countries, is strongly opposing the
plan.

The IMF has postponed the disbursement of its second $3
billion tranche of bailout funds originally scheduled for March
15.

Yesterday, banks responded to BI's interest rate move by
decreasing some of their interest rates.

Bank Dagang Nasional Indonesia (BDNI), for example, now offers
a 24 percent interest rate for a one-month deposit, 22 percent
for three months, 25 percent for six months and 20 percent for 12
months.

Bank Bali's rate for one and three months is 28 percent, while
the rate for six and 12 months is 26 percent.

Although some of the rates are still higher than BI's new
ceiling, they dropped from previous rates of about 30 percent for
the one month deposit.

Based on the new formula, interest rates for the one-month and
three-month time deposit, for example, should be set at 27.5
percent and 23.75 percent respectively.

"There's an adjustment period of about one week," Che Wei
said.

He said it would be difficult for BI to enforce its new
measures effectively. He pointed out that the limits would only
benefit solid banks, while there would be more incentive for
weaker banks to break the new regulation to secure liquidity in
order to meet obligations.

"Faced with the choices of either breaching BI's ruling or
default, banks would prefer the first," said Lin, adding that it
was also in the interest of the central bank to prevent bank
collapses, which could affect the entire banking sector as in the
case of the 16 banks closed down in November.

"So the government needs to get rid of the rotten ones first,"
he said. (08)