Lower interest rate won't weaken rupiah: Sjahril

JAKARTA (JP): Bank Indonesia Governor Sjahril Sabirin said on Saturday that the central bank's policy to further lower its interest rate would not necessarily lead to a weakened rupiah.

He said the measure could instead pave the way for strengthening of the currency due to improved confidence in the economy.

Sjahril emphasized that there was a tendency since September 1998 for declining interest rates to cause strengthening of the exchange rate of the rupiah to the U.S. dollar.

"But this possibility must not make us overly optimistic because it could create carelessness and unpreparedness in anticipating possible risks," he said in a speech at the anniversary celebration of YARSI University.

The central bank has allowed the interest rate of its one- month benchmark SBI promissory note to decline at a pace above market expectations since March.

It is now slightly more than 35 percent, compared to 70 percent in September.

Sjahril earlier said the interest rate could continue to gradually decrease despite jitters over possible escalating political tension ahead of the June general election.

But the International Monetary Fund, the organizer of an economic bailout program for the country, has warned that the domestic interest rate should remain high until there is a strong sign of improving confidence and that inflation is under control.

Many economists have joined the fund in fearing that an aggressive decline in interest rates will undermine the rupiah and trigger a rise in inflation.

"But this simple way of thinking forgets that there's another influential factor, that is a change in confidence," Sjahril countered.

He said that enhanced confidence could accelerate the country's economic recovery quicker than many people earlier projected.

He explained the confidence factor could effect an upward spiraling effect in which improving confidence could strengthen the currency, which would in turn strengthen confidence in the outlook of the economy.

Sjahril noted the country's economic crisis, which started in the middle of 1997, was provoked by a drop in confidence, which sent the rupiah tumbling and inflation soaring.

He added that the tight monetary policy employed by the central bank since early last year helped rebuild confidence because the market considered it a "we mean business" attitude.

"These measures and transparency (in monetary policy) have been an important factor in rebuilding confidence." He added that the government's consistency in its economic reform programs also was a positive factor.

The country posted 0.18 percent deflation in March from the level in February. The rupiah has flirted with Rp 8,600 to the dollar during the past several months, compared to a record-low Rp 17,000 at the height of the crisis in January 1998.

Independent economists, however, warn that inflation may increase again in the run-up to the June general election, which may prompt the central bank to allow the interest rate to increase in an effort to curb inflation and prevent the rupiah from plunging.

A lower interest rate and a stable macroeconomic condition are key factors to ensure the success of the government bank recapitalization program, itself essential to achieving economic recovery.

A high interest rate environment poses a threat to the banks' capital condition because of the negative interest rate spread problem, resulting from the higher time of deposit interest rates than the lending rates charged by the banks.

It also obstructs restructuring of the high rate of nonperforming loans of the banks.

"Lower inflation and a stable currency will prompt a further decline in interest to the normal level, which will help alleviate the negative spread problem suffered by the banks and strengthen their capital condition," Sjahril said. (rei)