Discount rate raised

Discount rate raised

Bank Indonesia's decision to raise its discount rate by 0.25 point last Friday following the 0.50 point rise in the U.S. Fed key interest rate is indeed essential to preventing another wave of currency speculation.

Another aspect, however, is the fact that the measure will obviously hurt small and medium-scale banks which, unlike the big banks that have ample access to the inter-bank market, rely largely on the central bank's short-term funds. But because both the Fed move and Bank Indonesia's reaction were widely expected, the impact of the 0.25 point rise on the prevailing interest rates will not likely be overly significant.

Moreover, because most banks raised their deposit rates by between one to two percentage points last month, the latest rise in the central bank's key rates -- the second after the 0.50 point increase in the middle of last month to defend the rupiah against speculation -- will not necessarily force another increase in the deposit and lending rates.

Also, the central bank's measure is timely for providing the right signal to the market, especially after the speculative pressure on the rupiah three weeks ago as fallout from the financial crisis in Mexico.

The right signal, as well as consistency and predictability of the central bank's monetary policy, are crucial because the country pursues a free foreign exchange regime and the exchange rate of its rupiah is floated against a basket of major foreign currencies. In such a situation, the central bank cannot afford to have its interest rate (monetary) policy independent from its exchange rate management as the international interest rates, notably those in the United States, have direct influence on the domestic currency market.

However, the subsequent developments in the interest rates still depend on the expectations for inflation this year. The government has pledged to check inflation throughout the year at less than six percent. Based on this target, the rupiah depreciation against the American dollar is envisaged at four percent at the most for the whole year.

We have often heard the government state its determination to curb the inflation rate at a single-digit level. For sure, a single-digit level has been achieved over the last two years -- 9.77 percent in 1993 and 9.24 percent in 1994 -- but those figures tottered on the brink of the two-digit level.

Many analysts are doubtful that inflation can be checked at the government's targeted level in view of the inflationary pressures from the recent rise in civil service salaries and the increase in the regional minimum wages and mandatory Idul Fitri bonus payments to workers. In fact, the inflation rate was already 1.16 percent in January. Although that rate was not unusual, because the first month of the year usually posts the highest monthly rise in the consumer price index due partly to the government-mandated annual increase in the producer rice price, the price increases in January were still worrisome. We think the achievement in checking the rate of inflation for the first quarter will be quite crucial for the success of the anti- inflation measures, especially in view of the seasonal price rises during the Moslem fasting month this month and the Idul Fitri holidays next month.

Bank Indonesia's Governor Soedradjad Djiwandono has been doing his share in the anti-inflation drive by tightening the money supply. But, as he frankly admitted at a hearing with the House of Representatives last week, monetary measures, although very important, are only one of the components of the anti-inflation program. The central bank's efforts will be rendered less effective than possible if the distortions and hurdles in the production and distribution sectors are not removed or at least minimized. Hence, the pivotal role of new packages of deregulation measures and bureaucratic reform.