Deposit rate rises

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.