Pricey credit and oil

Pricey credit and oil

Businesses in Indonesia may have to wait a while for a
significant decline in interest rates as Bank Indonesia,
concerned by strong inflationary pressure from the weakening
rupiah, or rather the strengthening U.S. dollar, and the steep
rise in international oil prices, is delaying easing its monetary
stance.

The appreciation of the greenback against most currencies in
Asia due to the imminent tightening of the money supply in the
United States, and oil prices that have soared to a 13-year high
of US$40 per barrel (unadjusted for inflation), have again raised
the specter of high inflation. This is particularly frightening
for Indonesia, where spending for the legislative and
presidential elections is expected to increase the base money
supply way above the aggregate monetary target.

It is now much more difficult for Bank Indonesia to maintain
the rupiah within the band it considers conducive for exports,
and yet not too low as to induce imported inflation. Since the Rp
8,200 to Rp 8,700 band set by the central bank as the target
range is no longer feasible after the appreciation of the dollar
since early this month, a new exchange rate target band has to be
set to prevent excessive speculation. Like it or not, the U.S.
dollar is the world's reserve currency, widely held by the
central bank, and disruption of the dollar disrupts the entire
world economy.

The rupiah is highly vulnerable to speculative attacks because
banks, with the high risks involved in corporate lending, are
still awash with excess liquidity. Moreover, most of the Rp 890
trillion in third-party funds at banks consists of deposits that
can easily be shifted to dollar assets at the expense of the
rupiah.

Bank Indonesia gave the signal for pricier money last month
when it jacked up the ceiling interest rates on time deposits
eligible for reimbursement under the government blanket guarantee
scheme. Many midsize commercial banks immediately responded by
slightly raising their deposit rates.

The steep rise in international oil prices is stoking
inflationary pressure that may also force tighter monetary
policies in Europe and Japan, which would slow the global
economic rebound.

For Indonesia, soaring oil prices will cause problems rather
than windfall profits, because, despite its daily output of
almost 1.2 million barrels per day, the country is now a net oil
importer.

The weakening rupiah and soaring oil prices are creating a
dilemma for the government. Certainly, it would be political
suicide for the government to raise domestic fuel prices ahead of
the upcoming presidential elections. But maintaining fuel prices
at their current levels will increase fuel subsidies, adding to
the inflationary pressure because much of the oil revenue now
belongs to local administrations (as a result of local autonomy),
while subsidies are borne by the central government. All of this
will further force much tighter monetary measures, dampening
economic growth.

Most analysts agree that the period of cheap oil has ended,
with world oil production already at or close to full capacity
while demand continues to rise.

The Paris-based International Energy Agency estimates world
oil demand will rise by four million barrels per day between now
and the upcoming winter. The problem is that output in non-OPEC
countries will likely remain flat, while OPEC can pump at most an
additional 2.5 million barrels per day, as Saudi Arabia seems to
be the only member country still with spare capacity. In
addition, production in Iraq continues to be held up by security
disturbances.

The tightening of credit in China to prevent its economy from
a hard landing may decrease the growth in oil demand and take the
pressure off oil prices, as China, which consumes more than six
million barrels of oil per day, accounted for almost 35 percent
of the world economic growth over the past three years.

However, the credit restraints in China are already having
negative repercussions in most major exporting-countries in East
Asia, which have become increasingly dependent on China's thirst
for imported capital goods and industrial materials.

It is now most imperative that Bank Indonesia provide the
market with a strong and clear direction by coping with
inflationary pressure and curbing speculative attacks on the
rupiah.