Interest rates may rise next month

JAKARTA (JP): Bank interest rates, which have been sliding recently, will be put to the test later this month when banks have to settle their income tax, or early next month when they have to fulfill the new reserves requirement.

C. Harinowo, head of the monetary management department at Bank Indonesia, said bank interest rates had been decreasing by up to 2 percent due to over liquidity in the banking system and a lower inflation rate.

He, however, said the downward trend in interest rates might be halted by an increase in the central bank's reserve requirement early next month.

"Interest rates will stop decreasing in the short term when supply (deposits) and demand (credits) reach a new equilibrium," Harinowo said after addressing a seminar at the Centre for Strategic and International Studies here Thursday.

Harinowo said prime lending rates at large banks currently stood at 18.5 percent per annum, compared to over 20 percent early last year. Prime deposit rates currently stood at 16 percent, compared to up to 19 percent early last year.

He said the oversupply of funds in the banking system would diminish soon when banks had to pay their income tax which is due this month and deposit some of their third parties' funds with the central bank as mandatory reserves.

Bank Indonesia announced the new reserve requirement last September, requiring banks to place 5 percent of their third parties' funds (time deposits, savings and cash) in their accounts at the central bank. The current reserve requirement is 3 percent.

In the long run, Harinowo said the level of domestic interest rates would be influenced by the level of inflation and the U.S. Federal Reserves' decision on interest rates.

Indonesia's interest rates have been considered among the highest in the region, attracting speculative funds to enter the country to benefit from interest rate differentials.

Local industries have been repeatedly complaining about the high interest rates.

The issue of cutting interest rates surfaced last year when State Minister of Research and Technology B.J. Habibie proposed the central bank spearhead efforts to halve interest rates.

His call drew wide support, forcing state banks to cut their deposit and lending rates by between 0.5 percent and 1 percent late last year.

Private banks, spurred by more liquidity and political pressure, followed the state banks' rate cuts.

"If Bank Indonesia tried to bring the rates down, would you still maintain the current rates or even increase them?" asked Rudy Ramli of Bank Bali.

The central bank has taken steps to lower interest rates through several instruments, including reducing the interest rates of Bank Indonesia Certificates.

The certificates' annual interest rates dropped from more than 13 percent in early 1996 to about 12 percent at the end of the year and 11 percent late January.

Political pressure

Harinowo contended that cuts in Indonesia's interest rates were purely driven by market mechanism, and not by political pressure.

He said large banks currently had too much liquidity because the amount of funds they raised from the public exceeded that of their credits last year.

Last year, third parties' funds at the country's commercial banks rose by Rp 53.6 trillion (US$22.2 billion) to Rp 201.4 trillion as of last November. Meanwhile their credits increased by Rp 44.5 trillion to Rp 258.4 trillion.

In 1995, third parties' funds increased by Rp 45.9 trillion, while credits grew by Rp 48.4 trillion.

Besides, Harinowo said, Indonesia recorded a lower inflation rate last year, at 6.47 percent, compared with 8.64 percent recorded in 1995.

"From last year's inflation rate alone, banks could cut their interest rates by 2 percent," Harinowo said.

Economist Hartojo Wignjowijoto argued that the declining domestic interest rates were largely driven by the movement of interest rates in developed countries, especially in the United States.

He agreed that the country's banking system held too much liquidity as a result of incoming foreign exchange, especially U.S. dollars which is used to benefit from interest rate differentials.

Bank Indonesia data shows that net foreign assets in the country's banking system increased dramatically from Rp 31.9 trillion as of January 1996 to Rp 50.6 trillion as of last December.

Because of over liquidity in the banking system, the central bank earlier this month lowered its discount rate for short-term money market securities by 50 basis points.

The central bank did not announce the cut but money dealers said the key rate for one-week securities was cut to 14.75 percent, for two-week securities to 15 percent and for one-month securities 15.50 percent.

Money market securities are short-term securities purchased by the central bank to inject liquidity into the banking system. (rid)