'Habibie's theory on interest rates unworkable'

'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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