High interest rates

High interest rates

Indonesian businessmen who complain about the persistently high costs of bank loans should not expect any significant drops in the domestic credit interest rates in the near future. All monetary indicators and the ongoing internal consolidation at most banks rule out any meaningful interest-rate decreases.

Bank Indonesia's (central bank) Governor Soedradjad Djiwandono when talking to reporters after the inauguration of new members of the Indonesian Bankers' Institute last Thursday also hinted that it was highly probable that interest rates would remain at their current rates (20 percent or 21 percent).

Indeed, the latest monetary indicators are such that there will not be much leeway for an easing of the monetary policy in the near term without sending the wrong signal to the financial markets. The money supply has expanded by 26.5 percent in the first nine months of this year, compared to 21.5 percent in the corresponding period of last year. The inflation rate, although likely to remain slightly below last year's 9.24 percent, will still be on the high side of the single-digit range.

The widening deficit in the current account of the balance of payments, due largely to the steep growth of imports, is another constraint that needs to be taken into serious account. It is true, as Soedradjad noted at the opening of the Asia-Pacific forex meeting on Friday, that although the current account deficit is expected to increase to around three percent of gross domestic product from only 2.3 percent ($3.7 billion) last year, this will still be manageable. In any case, the overall balance of payments is likely to show a surplus this year due largely to big capital inflows.

Nonetheless, lower interest rates are not economically viable right now. Cheaper credit would further stimulate imports, thereby causing stronger pressures on the external balance and bringing back the specter of double-digit inflation. As matters stand, imports will continue to surge due to the dramatic increase in the licensing of new foreign and domestic investments this year, even without a cut in interest rates.

We feel the need for bigger capital inflows also requires the maintenance of high differences between domestic and foreign interest rates even though the capital this interest differential attracts is mostly short-term.

The internal condition of most major banks also speaks against lower interest rates. First of all, most major banks are still grappling with problem loans and are undergoing intensive consolidation to meet the prudential regulations which were made much tougher by the central bank last September.

The September ruling raises the minimum paid up capital of foreign exchange banks to Rp 150 billion ($65 million) and the capital adequacy ratio (against risk weighted assets) to 12 percent, higher than the eight percent minimum set by the Bank for International Settlements. Even though the new capitalization requirement is effective immediately only for new forex banks, the existing ones will also have to conform with the new regulations within six years.

The new rulings, we reckon, will force bank owners to be especially careful about their bank management as they will have bigger stakes in their bank operations. For the time being, until the banks can raise their paid up capital either through mergers or share flotations, they will have to curb the pace of their credit expansion and simultaneously tap private savings to a greater extent. This in turn will become another block on interest rates coming down.