Overheating threat still looms

JAKARTA (JP): Bank Indonesia Governor J. Soedradjad Djiwandono said yesterday the national economy had started to cool but warned that a relaxed monetary stance could cause it to overheat again.

The governor of the central bank told an annual bankers dinner last night that monetary policy this year would continue to focus on strengthening internal and external macroeconomic stability.

"Therefore, an indicative target of 17 percent has been set for the expansion of claims on the business sector (lending) and this is expected to bring the growth of the economic liquidity (M2) down to 18 percent," Soedradjad said.

Soedradjad, who hosted the dinner, briefed local and foreign bankers on last year's monetary developments and charted out the direction of monetary management and likely challenges in banking this year.

He said monetary policy aimed to maintain domestic interest rates at a level capable of maintaining internal and external equilibrium and reducing the gap between offshore and domestic interest rates to a reasonable level.

"The real interest rates are expected to ensure that growth of domestic demand is consistent with the effort to bring down inflation and the current account deficit," he added.

Soedradjad said that non-oil import growth had been cut from 26 percent in 1995 to 10 percent last year, and the annual growth of broadly-defined money supply (M2) from 31 percent to 26 percent.

The annual growth of bank financing (lending, securities, equity participation etc.) for business had dropped from 22 percent in 1995 to 19 percent last year and the inflation rate had dropped from 8.6 percent to 6.5 percent, he said.

"But bank lending and the M2 continued to exceed the desired targets," he warned. These trends indicated that economic overheating had not completely subsided.

Soedradjad called for more vigilance on the foreign exchange market's susceptibility to domestic and international turbulence caused by non-economic factors.

He also warned about the rapid growth of private offshore borrowing, which constituted almost 50 percent of the country's outstanding foreign debt of US$110 billion.

An inefficient use of foreign borrowings would only create future problems given the large foreign debt and high debt service ratio, the governor said.

Indonesia's debt service ratio -- the ratio of debt servicing obligations to export revenue -- is 31.7 percent, of which 15.5 percent is contributed by the private sector.

Soedradjad suggested that private inflows be channeled to finance export-oriented activities that would support their repayments.

"In this regard, the assessment of private sector projects financed by offshore borrowing should be carried out more rationally and objectively based on each borrower's condition," he said.

On the latest banking developments, he said the number of commercial banks had stayed constant at 239 last year but 439 more bank offices had opened.

The number of banks which failed to comply with the capital adequacy ratio fell from 21 to 16 banks, he said.

"But during 1996, more banks violated the legal lending limit and the small-scale credit requirement. There has also been a similar trend observed in violations by foreign and joint venture banks of the export credit requirement."

To strengthen local banking, he said, the central bank would continue to encourage consolidation and mergers among banks.

Such measures might be voluntary, such as those aimed at increasing the competitiveness of local banks, or they might be compulsory in regard to saving problem banks.

The government recently issued a regulation on bank liquidation, which according to Soedradjad, aimed to provide legal certainty and increased protection for depositors if a bank was liquidated.

To increase the effectiveness of bank supervision, Bank Indonesia launched a pilot scheme last year to allow chartered public accounts to examine banks.

Soedradjad said an initiative was also underway to improve the terms of reference for bank examinations through a pilot project to examine eight banks which suffered complicated problems.

He said the central bank was coordinating efforts with the Attorney General, the chief of the National Police Force and other parties to deal with bank fraud and money laundering.

The government is looking into ways to let the central bank investigate bank fraud. The central bank is expected to be able to investigate the more technical aspects of fraud, while the criminal aspects would be handled by the police or the Attorney General's Office.

The governor said that banking policy this year would continue to focus on the development of a sound, competitive banking industry.

"This is essential because banks assume a special function in the process of creating money supply and maintaining the stability of the national financial system, and therefore play a pivotal role in the implementation of monetary policy," he said.

The government is drafting a regulation on banking secrecy to help the central bank and related institutions solve the bad debt problems which have long haunted the banking industry.

To improve risk management, Soedradjad said, the central bank would continue to encourage banks to adhere to self-regulatory banking principles while improving their management, human resources and technological infrastructure. (vin/rid)