Debate over Habibie's call on rates continues

JAKARTA (JP): The debate over State Minister of Research and Technology B.J. Habibie's controversial call to cut interest rates continued yesterday, with more economists calling his suggestion an absurd idea.

Rizal Ramli, a director of the Econit advisory group, said that Habibie's call to cut annual lending rates gradually to as low as 4 percent is unrealistic.

"The appeal to cut the interest rates to such a low level is quite strange and it could add to uncertainty in the country's economic outlook for 1997," Rizal said while presenting Econit's 1997 economic forecast.

Habibie said that Indonesia's interest rates, which might be the highest in the world, should be slashed to as low as 4 percent per annum under what he termed the "zig-zag" mechanism.

According to Habibie, the monetary authority should set a target to lower interest rates to 4 percent, for example, by 2010 when the Asia-Pacific Economic Cooperation (APEC) forum's free trade arrangement is fully implemented.

In order to meet this target, the monetary authority should start lowering deposit interest rates to 8 percent per annum from the present rate of 16 percent, he said.

Rizal is not alone in his concern. Other economists and banking experts such as Rijanto and Faisal Basrie have also questioned Habibie's monetary hypothesis.

The most shocking idea, however, is not Habibie's suggestion on how to reduce interest rates, but his theory about inflation.

Habibie -- known as 'super minister' because of his close relationship with President Soeharto and his strong influence in shaping the country's economic policies -- blamed the country's high inflation rates on its high interest rates.

Interest rates, according to Habibie, should therefore be reduced in order to cut inflation rates.

This notion runs counter to conventional monetary doctrine, which says that lower interest rates fuel economic growth, which in turn incites stronger inflationary pressure on the economy.

Rizal said that Habibie's inflationary theory is a new and untested hypothesis.

However unusual Habibie's theory about the relationship between interest rates and inflation, most economists agree that the country's interest rates are too high.

But economists also say that to cut interest rates overnight by more than 3 percentage points is nearly impossible.

A single percentage point is of major significance to the economy, Rizal said. If interest rates were lowered by 4 percentage points, the cut would incite massive outflows of short-term funds overseas, which in turn would shake Indonesia's monetary system.

Deposit rates could be reduced at most by 1 percentage point next year from the present rate of 16 percent, Rizal said.

"The cut is possible due to the estimated decline in the inflation rate by 1 percentage point to 7 percent this year," he said.

According to data provided by the Far Eastern Economic Review, Indonesia's prime (lending) rate is 17 percent per annum, much higher than 2 percent in Singapore, 8.2 percent in Malaysia, 15 percent in Malaysia, and 13 percent in Thailand.

Indonesia's real interest rate (the prime rate minus inflation rate) is 10.9 percent, much higher than 0.4 percent in Singapore, 4.9 percent in Malaysia, 6.3 percent in the Philippines and 7.6 percent in Thailand.

In other words, the Indonesian banks' interest margin is also much higher than their counterparts in four neighboring countries.

Faisal and Rijanto, like Rizal, said that the interest rates charged by domestic banks are higher because of their structural problems.

"It will, therefore, be difficult for the central bank to use its power in lowering the rates if the problems in the banking industry are not thoroughly addressed," Rizal said, stressing that local banks are inefficient because of cross-ownership between financial intermediaries and because of high rates of bad loans.

Minister of Finance Mar'ie Muhammad declined to comment on Habibie's call to sharply cut the interest rates or on his inflation theory.

Bank Indonesia Governor J. Soedradjad said Monday that the central bank has been working hard to reduce both the country's inflation and interest rates.

"We do not only let the interest rates on the market mechanism but also control it through market interventions," he said. He too, declined to comment on Habibie's appeal. (hen)