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.