Choking interest rates

Pressure has been mounting on the monetary authorities to lower bank interest rates which have been crippling economic activities since early this year. But the decrease of several percentage points in time deposits at major banks over the last few days -- as a result of the fall in the central bank's benchmark rate from 70 percent in August to 60 percent this month -- should not mislead businesspeople into high expectations for significantly lower lending rates this year, or even in 1999.

Indications are quite strong that lending rates could remain as high as 50 percent until next year because current circumstances in the country are simply not conducive for a substantially eased monetary policy. This is despite the strong recommendation by both the World Bank and International Monetary Fund for pump-priming policies in crisis-afflicted Asian countries, including Indonesia.

Bank Indonesia, the central bank, seems determined to hold firmly to the basic rule that the interest rate policy cannot be decoupled from exchange rate management. This implies that the high interest rates will have to be maintained if the rupiah's exchange rate -- although strengthening to slightly below 10,000 against the American dollar from as high as 12,000 in August and September -- is seen as shaky and greatly susceptible to sudden jolts from social and political tensions.

The monetary condition is still so fragile that nothing else will likely happen unless the rupiah rate stabilizes to a reasonable level. It is feared substantial cuts in interest rates amid the wildly fluctuating rupiah would prompt movement of deposits from banks to currency speculation.

But the exchange rate policy aside, many analysts are doubtful as to whether a significant cut in interest rates is possible now in view of the high anticipation of inflation. The consumer price index rose cumulatively to more than 75 percent in the first nine months, and is estimated to reach at least 90 percent for the whole year. The dilemma, though, is that inflationary pressures will remain strong without a stronger rupiah.

Fiscal stimulus -- another alternative for reflating the economy -- is not feasible either because the State Budget is already envisaged to suffer a deficit of as much as 8.5 percent of the Gross Domestic Product, due mostly to huge spending on subsidies for basic food staples, fuel, electricity, medicine. education and other essential needs.

The question then is whether letting the monetary policy remain as punitively tight as it is now would not be more devastating to the fundamentals of the economy. After all, the macroeconomy is only as healthy as its business units, and likewise the banking system is only as sound as its corporate clients. The more than 70 percent decline in the rupiah's value since July 1997 has already shoved most businesses into technical bankruptcy.

As most banks are also being crippled by huge debt burdens and increasing bad loans, lending to the corporate sector has virtually stopped. This has practically closed all coronaries of lifeblood to the business sector since the moribund capital market, where two thirds of the 288 listed companies are already technically bankrupt, is not viable for the flotation of either equity shares or debt instruments.

True, interest rate cuts are highly risky and not sustainable if the investment risk premia remain as high as they are now in view of the political uncertainty and high risks of social tensions. Moreover, lower interest rates are meaningless until banks, most of which are now in negative net worth, are recapitalized.

However, the bank recapitalization program, currently under preparation by the central bank, is slated to be completed only in January. Denying much longer the business sector, especially small and medium-scale enterprises, desperately needed credits will lead even good companies into bankruptcy.

Given such a desperate situation, we think the government should extend more budgetary subsidies for low-interest credits, not only to farmers but also to tightly selected small and medium-scale firms in highly prospective sectors, such as agrobusiness and fisheries, and export-oriented manufacturers.