Falling interest rate

Falling interest rate

Bank Indonesia has steadily lowered its benchmark interest
rate since early last year in a bid to fuel economic recovery and
to prod banks to increase new lending to liquidity-starved
businesses.

The easier stance on money has been made possible by
macroeconomic stability, which has been strengthening on the back
of a stronger rupiah and low inflation.

The consumer price index has also been falling steadily to
bring down inflation to as low as 5.06 percent last year, from
10.03 percent in 2002 and 12.56 percent in 2001.

This low inflation rate can be attributed primarily to the
appreciation of the rupiah, which has itself been fueled by a
sharp reduction in country risks -- as indicated by international
credit rating agencies and in steadily increasing foreign
exchange reserves, portfolio capital inflows and a weakening
dollar.

Macroeconomic stability is expected to increase further this
year, as there seems to be no big risk of a sharp deterioration
in key economic indicators, despite the national elections
between April and September.

Barring any major security disturbances or political violence,
the rupiah will most likely continue to appreciate or, at worst,
remain stable at its current rate of around Rp 8,500 to the
dollar. In turn, this will create a virtuous cycle in the economy
and push down inflation further.

The government conservatively projects an average rupiah rate
of Rp 8,600, inflation at 6.5 percent and benchmark interest rate
at 8.5 percent for this year, and the market seems to be
comfortable with these assumptions.

Bank Indonesia (BI) also seems highly optimistic that
inflation will continue to be well controlled throughout 2004.

Over the past five weeks alone, the central has decreased its
benchmark interest rate from 8.3 percent in December to 7.86
percent last month, and may further cut its interest rate at the
weekly auction of its promissory notes today.

However, the very slow response from the banking industry to
BI's strong signal of an easier money stance is worrying. Banks
still seem to be facing great difficulty in extending its excess
liquidity to lending. For example, when Bank Indonesia lowered
the interest rate of its promissory notes from 8.06 percent to
7.86 percent during the weekly auction on Jan. 28, banks still
bought more than Rp 55 trillion of the notes.

Most banks must also find it very difficult to extend its
funds to corporate lending; otherwise, they would not have
forfeited a potential earning of 4 to 7 percent. This is the
difference between interest revenues banks will get from
commercial loans -- between 11 and 15 percent -- and from BI
promissory notes -- 7.86 percent.

Banks apparently remain hesitant about accelerating the pace
of corporate lending, due to high credit risks turning sour and
thereby threatening their capital standards.

But this condition is inimical to economic recovery. If banks
remain highly averse to new lending and instead prefer to invest
in financial market instruments such as mutual funds, government
bonds, BI deposit certificates, treasury bonds and inter-bank
market instruments, economic recovery will remain weak.

Understandably, banks should be extra careful in making big
corporate loans, because most big businesses have yet to complete
restructuring their operations and bad loans.

However, there are now thousands of small and medium-scale
enterprises (SMEs) that are starved of investment and working
capital loans. The major banks, despite their acute lack of
expertise in dealing with SME borrowers, could channel excess
liquidity to help these businesses through cooperation with
secondary banks that have long experience in lending to SMEs.

Lending to SMEs, which make up most of the business sector and
employ millions across the country, will not only speed up
economic recovery, but will also provide banks with bigger
earnings -- with the eventuality that some medium-scale
businesses will become big enterprises and prime clients for big
banks.

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