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)