BI rate hike to hamper growth

Zakki P. Hakim and Urip Hudiono, The Jakarta Post, Jakarta

While an employers' organization welcomed Bank Indonesia's (BI) move to increase its benchmark interest rate, which immediately strengthened the rupiah, it also expressed fears that the move would adversely affect the real sector and the achievement of economic growth targets.

"Increasing the benchmark interest rate will lead to higher lending rates, which will cause problems for the real sector," Indonesian Chamber of Commerce and Industry (Kadin) chairman Mohamad S. Hidayat said.

BI raised its benchmark interest rate from 8.75 percent to 9.5 percent on Tuesday, a move that immediately bolstered the rupiah and lifted share prices.

Hidayat said the move would increase the lending rate to 16 percent, which would in turn discourage new investment.

"As a result, everybody will wait. I hope they will not speculate on the forex market while waiting," he said.

He stressed that if things did not improve in the next couple of months, it would be impossible for the government to achieve next year's growth target of 6.2 percent.

However, Standard Chartered economist Fauzi Ichsan, who has been suggesting that the BI rate be raised to double digits to help the rupiah, refuted the notion that the rate hike would have adverse impacts on the country's banking industry and economic growth.

"This is because what is needed now is a clear signal to restore the market's trust in the rupiah, and BI has given just that," he said. "Banks will also continue to enjoy a differential of up to 5 percent between their lending rates and deposit rates."

A higher central bank interest rate usually results in higher deposit rates, which in turn leads banks to also increase their lending rates as to maintain their profits on the differential. Higher lending rates, however, make it more expensive for firms to borrow in order to expand their businesses.

Fauzi warned, however, that the positive effect of the BI rate hike might not be sustained if it was not coupled by similar positive signals to the market from the government.

"The government must cut fuel subsidies through another domestic fuel price hike," he said.

"They can do it gradually, like BI has done with its rate so as not to result in counterproductive effects, such as surging inflation."