BI signals higher local rates despite Fed rate cut

JAKARTA (JP): Bank Indonesia said on Friday that lowering local rates to adjust them in line with the United States' Federal Reserve Bank (Fed)'s interest rate cut was untimely, and warned that domestic rates might even rise further.

Bank Indonesia Governor Sjahril Sabirin said cutting local rates would not be appropriate given Indonesia's current economic conditions.

"The time isn't right for us to lower interest rates, but whether they will continue to rise, we'll have to see," he told reporters after a closed-door meeting with the House of Representatives' budget commission.

The Fed on Wednesday cut its federal funds rate -- the rate used for overnight interbank loans -- by a slight 25 basis points to 3.75 percent.

The Fed's latest interest rate cut marked the sixth reduction in its federal funds rate since early this year to help cope with a slowdown in the country's economy. Before the rate stood at 6.5 percent.

A reduction in the Fed's rates often triggers central banks in other countries to follow suit, particularly those whose currencies are pegged to the U.S dollar.

But in contrast, Indonesia's SBI rates have been steadily rising this year.

From around 14 percent early this year, the SBI (benchmark) rate rose to 16.65 percent at the latest auction on Wednesday.

Sjahril said earlier the tight monetary policy was necessary as Indonesia's economy was different.

While other countries slash interest rates to spur economic growth, Indonesia has been increasing its rates to reduce pressure on the rupiah and, consequently, reduce inflationary pressures.

But analysts are in doubt whether higher interest rates are still effective in controlling inflation and the rupiah rates.

Since March, the year-on-year inflation rate has been hovering at over 10 percent. The government's target is 9.3 percent.

Upward pressure on inflation is likely to increase, given the government's move to hike fuel and electricity prices and the weakening rupiah which raises the cost of imports.

On the foreign exchange market, the rupiah is still performing below the government's assumption of 9,800 against the U.S dollar for the current fiscal year.

The rupiah closed at 11,410 to the dollar on Friday afternoon.

Bank Indonesia's reliance on SBI rates to meet its monetary targets is also contributing to a widening state budget deficit.

A large portion of bank recapitalization bonds, worth Rp 430 trillion (about US$38 billion), carry interest rates tied to the SBI rate.

The higher the SBI rate, the more interest the government must pay on the bonds.

Bank Indonesia Deputy Governor Miranda Goeltom said that interest rates are likely to increase, citing lingering uncertainties.

"Instability and uncertainties are causing money to flow into the market. We're trying to get that money and prevent it from being used for speculation," she explained.

Miranda was referring to the ongoing political dispute between President Abdurrahman Wahid and legislators, which has become a catalyst for speculative trading in the money market. (bkm)