Interest rates rise

Interest rates rise

The new wave of increases in bank deposit rates over the last
few days is not surprising at all, especially after the central
bank raised the discount rate on its short-term securities by a
half percentage point on Friday. That, we think, reflects in part
the market's doubts about the government's ability to curb
inflation.

Despite the government's reaffirmation of its commitment to
stronger anti-inflation measures at the monthly limited cabinet
session on economic affairs over the last four months, the
consumer price index has continued its upward trend. In fact, the
inflation last month reached 1.60 percent, almost three times as
high as that in March, when the consumer price index had been
expected to top the monthly increase due to the Moslem Idul Fitri
holidays. We wonder, how the government will be able to check
this year's inflation at a single digit, when the rise in the
consumer price index has reached as high as 4.7 percent in four
months.

The central bank's decision to raise the discount rate on its
short-term securities by a half percentage point on Friday, or
two days after the announcement of the April inflation rate, was
simply a logical response to the inflationary pressures. The
monetary authority is indeed required to play its part in curbing
the inflationary pressures through a tight monetary measure.

Friday's increase in the central bank's discount rate was the
third rise in the last four months. The discount rate was raised
by a half percentage point in January to cope with the
speculative attacks on the rupiah, that were set off by the
Mexican financial crisis, and by 0.25 percent in February as a
consequence of a similar move by the U.S. Federal Reserve.

A steady interest rate increase would obviously have a
dampening impact on new investment and affect share prices,
thereby discouraging new share issues, at least for the time
being. That in turn would increase the business sector's
dependence on bank loan funds as equity financing would become
restricted.

There is, we think, another reason that has compelled the
central bank to raise its discount rate and consequently the
interest rates to curb the strong inflationary pressures. The
central bank cannot separate its monetary policy from its
exchange rate management. If the central bank wants to maintain
the rupiah depreciation against the American dollar at the set
target of five to six percent this year, the interest rates have
to be raised, otherwise the market will not accept the prevailing
exchange rate as sustainable.

Nonetheless, as the central bank itself and most analysts
have acknowledged, monetary policy is only one of the measures
essential to curbing inflationary pressures. The central bank can
help curb demand-pull inflation by reducing the supply of money.
The problem, though, is that the current inflation pressures have
been caused mostly by higher costs, either in the production or
distribution of goods.

The persistently strong inflationary pressures during the
first four months of this year have made it more imperative then
ever for the government to further deregulate economic activities
and to remove monopolistic and oligopolistic practices in the
manufacturing industry. Hopefully, the new packages of reform
measures to be announced within this month will address most of
the factors which have thus far been identified as the main
causes of high production and distribution costs in the country.