Curbing credit growth

The central bank again moved to restrict credit growth and reduce speculative foreign exchange trading in a stronger bid to maintain monetary stability and contain an overheating economy. Bank Indonesia on Wednesday increased its intervention band for the rupiah by three percentage points to 8 percent and decided to raise the minimum reserve requirement ratio of banks by two percentage points to 5 percent of deposits beginning April 16, 1997.

The two measures, the central bank said, were designed to strengthen its monetary management in coping with an overheating economy and high credit growth, which has apparently exceeded Bank Indonesia's monetary targets.

The widening of the bid-offer band of the rupiah to the American dollar, for the second time in three months, immediately increases the risk of foreign exchange speculation while transferring most of the risk to speculators. This will consequently reduce the inflow of speculative capital. But the wider intervention band also offers more opportunities to private market makers and allows the central bank to maintain its level of foreign reserves at a comfortable level.

The monetary measure, we think, was well timed in view of the heavily political national agenda in the run-up to the general election within the next eight months. Short-term foreign funds which flow in to tap high domestic interest rates and portfolio capital on the stock exchanges are highly vulnerable to noneconomic factors such as political events, wild rumors and other speculation unrelated to economic fundamentals.

The wider intervention band will enable the central bank to manage its monetary targets better because it will not have to absorb a large amount of dollars in case of high inflows and draw on its foreign reserves in case of a reverse flow of foreign funds or a run on the rupiah. In the 1992/1993 fiscal year, for example, the central bank spent over $1 billion sterilizing short-term capital flows.

The central bank said the volume of foreign exchange trading in Jakarta had increased steadily from a daily average of US$5 billion last year to $7 billion in June and to as much as $14 billion by the end of July, apparently from the impact of the July 27 riots in some parts of the capital city.

Experience, however, shows that the intervention band only supplements the efforts required to maintain monetary stability. This measure is helpful only when macroeconomic management remains sound, the main policy framework remains stable and consistent and exports continue to grow faster than imports.

The rise in the minimum reserve requirement will further dampen credit growth because the banks must deposit a larger amount of earning assets at the central bank as idle money. This will raise their cost of funds and consequently drive up interest rates. The central bank was apparently disappointed that the commercial banks, notably the private banks, did not take much heed of its appeal for prudent lending. Bank lending has grown by more than 25 percent in the first seven months of this year, far higher than the annual target of 17 percent set early this year. Daily transactions on the inter-bank rupiah market have almost doubled from Rp 1.1 trillion last year to Rp 2 trillion in June.

But the central bank is fulfilling its commitment to avoid any shock-therapy measures by phasing in the higher reserve requirement only next April, or seven months after the widening of the rupiah's intervention band. Governor Soedradjad Djiwandono apparently wants to see the impact of the wider intervention band and the full effect of the one percentage-point increase in the reserve requirement last February.