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.