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.