Growth through cooperation
Growth through cooperation
The following is an excerpt of a statement made by Governor of Bank Indonesia J. Soedradjat Djiwandono at the Bankers' Annual Meeting on Jan. 19, 1996. This is the first of two articles.
JAKARTA: I see three major trends underlying domestic and international growth dynamics. The first trend is the intensification of international cooperation to create more open international trade flows at the multilateral and regional levels. The year 1995 recorded several major achievements in this area. The formation of the World Trade Organization (WTO) last year was a historical landmark in world trade liberalization. This development was further strengthened with the accord reached by the Asia Pacific Economic Cooperation (APEC) countries recently. In a narrower sense, we also witnessed the determination of ASEAN leaders to hasten the implementation of the ASEAN Free Trade Area (AFTA), which will take effect seven years from now.
Banks in Indonesia should note that the AFTA agreement includes trading in services which encompass financial services in the framework of AFTA and in accordance with the ASEAN Framework Agreement on Services (AFAS). Therefore, besides being committed to the General Agreements on Trade in Services (GATS), our financial services sector is also committed to AFAS.
The second trend which we can observe is the increasingly rapid integration process of world financial markets. This was made possible not only by the progress made in information and communication technology but also by deregulation in the financial sectors of various countries, including our own, as well as the many innovations in the financial and banking sector. A clear indication is the rapid fund inflows and outflows across the globe regardless of borders. On the one hand, the integration process is increasing the efficiency of fund allocations globally.
Nevertheless, an unavoidable fact of this integration process in the financial market is that it is increasingly complicated for a country to protect itself from external turbulences. This phenomenon is also evident in Indonesia in line with the increasingly active domestic money and capital markets. As a result, the domestic market is very susceptible to any disturbances in international money markets. The foreign exchange shake up in Indonesia and in several Asian countries after the Mexico crisis early last year was an example of the influence of the money market integration process, such as we have never expected before.
The third trend which I would like to present is the increasing role played by the private sector as an engine of growth in many countries. This development is a logical consequence of greater global free trade and investment.
The real sector as well as the financial sector recorded heartening growth. Nevertheless, it is undeniable that the challenges we are facing have not become easier. Potential macroeconomic imbalances threaten our accelerating economic performance, that is, the overheating of the economy in the form of a high inflation rate and larger current account deficit. Efforts to cool down the economy continued to be the central point of government policies in 1995 and also 1996.
As we are aware, the rapid growth of domestic demand was not balanced by growth in national production. Consequently, the previous year saw rapid import growth, especially in non-oil/gas imports at 29 percent. A large proportion of these imports comprised raw materials and capital goods, especially chemical, machinery, vehicles and steel. Import of consumer goods also increased, particularly for durable goods, besides a significantly high increase in import of essential foodstuffs such as rice and sugar.
Meanwhile, non-oil/gas exports during 1995 grew by 18 percent, an improvement from the 12 percent growth in 1994. Furthermore, non-oil/gas exports in 1995 signified the growth of major commodities such as textiles and the success of diversification efforts as witnessed in the increase of exports such as electrical goods, paper and chemical products.
With the rapid growth of import far exceeding export, the current account deficit for 1995/96 is estimated to increase to US$7.9 billion or comprising 3.8 percent of GDP. In comparison with 1995/96, this year's deficit is much higher. However, in view of the large capital inflow to the government as well as the private sector, the balance of payments is estimated to be in surplus. Foreign reserves will remain sufficient so that, overall, the balance of payments will still be secure.
I Would like to add that the growing current account deficit in 1995 was not a unique development experienced only by our country. A similar experience was faced by several countries with dynamic and expanding economy such as Malaysia and Thailand. In comparison, the current account deficit to Malaysia and Thailand are 7 percent and 6 percent of their GDP respectively. This is surely not an excuse for us to allow our current account deficit to increase. Instead, let us endeavor to reduce the deficit in 1996/97 towards a safe economic path for the future.
Accelerating domestic demand not only increased the current account deficit but also resulted in pressure for price increases in the country. As we have witnessed, the increase in the prices of cement, paper and several building materials for example, was partly caused by strong domestic demand.
Efforts to reduce the current account deficit and control the inflation rate are the priority of economic policies adopted by the government in the previous year. Measures which began last year will be continued and intensified this year. On the fiscal side, the government aimed to increase revenues while limiting expenditure to its planned level. On the monetary side, Bank Indonesia has taken steps to influence domestic demand through more prudent management of money supply; for instance, by increasing the effectiveness of open market operations and the level of the minimum reserve requirement
Besides that, Bank Indonesia has taken steps for banks to slow down the speed of credit growth which was a major source of money supply growth. The fiscal and monetary measures taken will not be as effective if they are not balanced by correction measures on the supply side for our economy. Therefore, the government has made continuous efforts to increase the efficiency of production and investment activities through, among others, the May 1995 package regarding the compliance of import regulations and the June 1995 package regarding investment, production and trade.
In the last months of the previous year, several indicators have begun to show to early encouraging signs. Since the third quarter of 1995, reserve money (MO) as well as money supply (Ml) slowed down significantly and until last December, the annual growth rate of MO dropped to 16.7 percent while growth rate of Ml dropped to 16.1 percent. Bank credit which achieved the highest annual growth rate of 27.0 percent in August 1995 has begun to show early signs of slowing down. By December, the annual growth rate of bank credit has declined to 23.5 percent.
Non-oil/gas import continues to grow beyond expectation although it has shown early signs of subsiding since last August. As we know, the inflation rate in 1995 was 8.6 percent and this was an improvement compared to the previous two years. However, we have to admit that the inflation rate is still far above the desired target. Therefore, the government will intensify efforts to achieve the inflation target by adopting necessary measures.
We should also note that inflation in 1995 was also influenced by supply side factors. This was due mainly to disruptions in the production and distribution of foodstuffs, especially rice and the increase in prices of imports in the international market. Accordingly, the success in curbing price hike is attributed also to the efficient flow of goods and services, particularly in the procurement and distribution of basic necessities.
Although several indicators that I have mentioned earlier demonstrated early positive signs for our efforts to cool down the economy, the same cannot be said for several other indicators. Although the growth rate of non-oil/gas export in 1995 had improved compared to the previous year, it was still colored by problems which will need to be overcome fundamentally.
The development of one of the monetary indicators, M2, was still not encouraging. Its growth rate was still too high and needs to be reduced. This was because two major components of M2 bank credit and foreign capital inflows, were still growing rapidly, although lately there were signs that credit expansion was subsiding. To this date, capital inflow is still strong. Part of it was related to the financing of bank credit itself. The other part became sources of finance of several economic activities in the country but it was not recorded as bank loans. Therefore, we must constantly be alert towards this inflow of capital, especially short term funds.
Regarding the large inflow of foreign funds in the previous year, I would like to point out that the development was partly encouraged by the existing high domestic interest rate. Besides that, there were fund inflows which attempted to take advantage of uncertainty niches for speculative purposes. However, other fund inflows were also related to the realization of foreign direct investments (PMA) as well as the increasing financial needs of business activities in the country for foreign commercial borrowing (PKLN). This is reflected in the increasing endorsement of PKLN by the private sector.
Existing information showed that private endorsements of PKLN, including financial institutions, was US$7.3 billion in 1995, far exceeding PKLN in 1994, which was to $2.3 billion. This was a different trend compared to previous year. During 1994, the buoyant capital market enabled businesses to obtain financial resources through the capital market. However it seems that in 1995 the capital market became less attractive as an investment alternative. This situation, as well as high interest rates, together with relatively tighter domestic liquidity caused some businesses to turn to foreign commercial borrowing.
Another matter which merits our attention is the increasing trend of private foreign commercial borrowing during 1995. We hope that those foreign commercial borrowings will be utilized productively, especially to boost exports. In this regard, banks can play an important role if the foreign commercial borrowings are channeled through domestic banks.
Therefore, I would like to request that channeling banks ensure that these funds are used productively, especially for export oriented activities. A misuse of foreign commercial borrowings will not only create potential problems but will also increase our outstanding foreign debt as well as debt payment ratio.
The increasing pace of capital inflows and outflows in our economy has also brought about new monetary uneasiness. Since recently, our economy has been frequently disrupted by inflows and outflows of funds, especially short term funds. As an effect of Mexican crisis, the spread of devaluation rumors as well as the change in the exchange rate system, we experienced three times in 1995 our domestic money market being shaken due to sudden surges of fund outflows. On the other hand, we have also witnessed a higher inflow of capital when the domestic interest rate increased, due in part to tighter liquidity.
In the face of this situation, Bank Indonesia took measures in 1995 to dampen the volatility in the foreign exchange market while simultaneously increased the effectiveness of monetary management. These measures were conducted in part through the intervention in the domestic foreign exchange market, the widening of the spread of Bank Indonesia's selling and buying rate in June 1995, and through the introduction of intervention band rates or 3 percent at the end of December 1995. Through these various measures, the development of the Rupiah exchange rate during 1995 was maintained to be realistic.
Window A: Accelerating domestic demand not only increased the current account deficit but also resulted in pressure for price increases in the country.
Window B: The government will intensify efforts to achieve the inflation target by adopting necessary measures.
Window C: The increasing pace of capital inflows and outflows in our economy has also brought about new monetary uneasiness.