Fiscal, monetary policy

Fiscal, monetary policy

The one to two percentage point increase in deposit interest
rates announced by many banks over the last few days might cause
inordinate concern about an impending credit crunch. However, the
net impact of the overall mix of fiscal and monetary policy, as
announced by the government last week, actually should create a
lot of opportunities for investors.

The fiscal policy is tight indeed, as can be seen from the
contractive impact of the 1995-1996 state budget because the
government will suck more money out of the economy through tax
collection than it will spend.

But the monetary policy targets of 19 percent expansion in
bank credit and an around 21 percent increase in the economic
liquidity (broadly-defined money supply) for the coming fiscal
year beginning in April cannot be viewed as a tight monetary
policy.

We see the mix of fiscal and monetary policy as the right
signal to further strengthen the confidence of both domestic and
foreign investors in the long-term prospects and stability of the
economy. The government's objective of checking the inflation
rate below six percent for the coming fiscal year should be
welcomed as a very wise policy. First of all, the expected rate
of increase in the consumer price index is greatly influential
toward interest rates and consequently to the rate of the
depreciation of the rupiah against major international
currencies, notably the American dollar. The three-percent target
zone set by the government for the depreciation of the rupiah
next fiscal year indicates that the government is really
determined to curb inflation at no more than six percent. The
assumption is that inflation in the United States will be about
three percent.

We also take the mix of fiscal and monetary policy as another
strong warning for the private sector to channel capital mostly
towards investment rather than consumption. This is particularly
important in view of the expected increase in the current account
deficit to almost $4.1 billion, or 14 percent larger than the
$3.58 billion estimated for the 1994-1995 fiscal year.

Such a warning is necessary especially to remind private banks
of their great responsibility. As a result of the massive
deregulation of the financial sector in 1988, the central bank's
monetary management now depends mainly on its open market
operations. Hence, monetary stability will also depend on the
personal responsibility of the private-sector bankers, who have
increased their proportional role to more than 50 percent of the
total banking industry's resources.

Provided the directive on prudent lending is properly
implemented, the projected level of the current account deficit
is actually not so detrimental because the expected capital
inflows should more than offset the shortfall. In fact, the
overall balance of payments can be expected to end the next
fiscal year with a surplus of $1.8 billion. We rest assured,
given past experiences, that the greatest portion of the private
capital inflow will consist of direct investment and not flighty
portfolio capital, which is greatly vulnerable to short-term
swings in investor confidence.

Moreover, the stronger monetary stability as a result of the
fiscal prudence will minimize the risk of the monetary authority
having to resort to drastic measures. That, in turn, will
encourage sound growth of the capital and financial market,
thereby providing the business sector with a broader variety of
financing alternatives, in addition to bank credits. Last year,
for example, almost $5 billion in fresh funds were raised by
companies through share and bond flotations.

We are confident, therefore, that barring another wave of
interest rate rises in major international financial markets,
domestic credit interest rates should most likely begin to
decline again in the second half of this year. If the anti-
inflation measures produce the expected result, the downward
trend in interest rates should be fairly rapid.