Deposit rate rises

Businessmen are naturally worried about the upward trend in the interest rates on short-term deposits (up to one year) because that means costlier funds and consequently higher operation or production costs.

This trend should indeed raise some concern because it is emerging at a time when most export-oriented companies are being forced to slash costs in order to strengthen their competitive edge on the international market.

One may simply conclude that the trend was caused by the recent 0.25 percentage point increase in the U.S. Fed fund rate to 3.75 percent. That inference is, to a certain extent, understandable because the two main factors which influence interest rates, especially in a country such as Indonesia that pursues an open-capital account (free foreign exchange regime), are the rate of inflation and the relationship of domestic interest rates to foreign interest rates.

The 3.95 percent inflation in the first four months of this year could be seen as unusually high, especially if it is set against the government objective of curbing the increase in the consumer price index at about seven percent this year. But analyzing the monthly trend of the inflationary pressures since January, we may feel assured that this year's inflation could be checked maximally at seven percent. The seasonal factors (New Year, Ramadhan and Idul Fitri holidays) that caused high inflation -- at 1.25 percent in January, 1.76 percent in February and 0.70 percent in March -- are over. Last month, for example, the inflation was checked at only 0.24 percent. We are confident that the government should be able to check the monthly rise in the consumer price index at below 0.30 percent for the next eight months.

But besides the inflation rate and foreign interest rates, there are at least two other factors that strongly influence the domestic interest rates. The first one is the expected rate of depreciation of the rupiah against the American dollar because that, besides inflation, also determines the real interest rate. But the rate of inflation is the main factor that determines the rate of depreciation.

Minister of Finance Mar'ie Muhammad has set the target zone of rupiah depreciation this year at six percent maximally. The other influential factor is the public's perception of the government's mix of macro and micro-economic policies. The adoption of the wrong mix of policies or ones which are inconsistent with the spirit and principle of the deregulation and market mechanism is not conducive to low interest rates.

That the public has not been fully assured of consistency in the government's policy can be seen from the fact that the bulk of time deposits at banks are kept in short-term (up to one year) accounts. That indicates uncertainty about the long-term outlook of state policy. The short-term nature of most deposits also makes it difficult for banks to significantly reduce their lending rates and to manage their loan portfolios.

Therefore, the government should cope with the current upward trend in the deposit rates by addressing the problems related to the main underlying causes of the high interest rates. The top priority should obviously be given to anti-inflation measures and continuation of the economic and bureaucratic reform measures.