'Habibie's theory on interest rates unworkable'

JAKARTA (JP): State Minister of Research and Technology B.J. Habibie's zigzag theory on interest rate reduction would fail in Indonesia because of its high mobility of capital, a University of Indonesia economist said yesterday.

"The zigzag theory can only work in countries with low capital mobility like a number of developed countries," Faisal Basri told a seminar on interest rate policies to improve Indonesia's competitiveness.

"I agree with the idea of reducing interest rates. But I think we should study further how we do it. Reduction of interest rates not only concerns monetary authorities but also other government institutions," he said.

He was commenting on Habibie's recent statement that interest rates in Indonesia were the highest in the world and therefore should be reduced in stages by applying his zigzag theory of interest rate reduction.

Indonesia's lending rates now average 20 percent a year, compared to Singapore's 7 percent, the Philippines' 12 percent, Thailand's 13 percent and Malaysia's 8 percent.

Habibie's theory, promoted in the last few weeks, has received mixed reactions from economists and the public.

At yesterday's seminar, organized by the Center for Information and Development Studies (CIDES), the minister pushed again for the implementation of his zigzag theory.

According to Habibie, the zigzag theory requires the monetary authorities to greatly reduce interest rates in the long term; by 2010, for example, when APEC's free trade arrangements take effect.

"Let me explain how it will work. First, for example, we reduce interest rates from 14 percent to 8 percent to generate economic growth. By the time the economy is overheating, the monetary authorities raise the rate to 12 percent. After cooling off, it should lower rates to 6 percent to encourage growth. Then the rates are raised to 10 percent, lowered to 5 percent...raised and lowered again until they are stable, for example, at 4 percent per annum," he said.

He said interest rate reduction should be made in stages over a long period to avoid destabilizing the macroeconomy.

Capital flight

Faisal warned that, if applied, Habibie's theory could result in harmful capital flight.

He criticized Habibie's view that interest rates influenced inflation: "I don't think so. All research using the Granger causality test has concluded that it is inflation which influences interest rates, not the other way around."

He said another study, by MacLeod, also concluded that the contribution of interest rates to total production costs was small or insignificant.

"So interest rates are not the key problem in improving the competitiveness of our products," he said.

He said, "It is almost impossible to control interest rates and inflation merely from a monetary point of view."

Faisal produced several solutions: The government should design a comprehensive and consistent macroeconomic policy with a clear coordinating mechanism for its institutions; the government should help the banking industry improve its efficiency to help lower interest rates; And the government should eliminate policies which encourage rent seeking by certain businesses. (bnt)

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