Soedradjad gives elements in economic achievement
Soedradjad gives elements in economic achievement
The following article is based on a paper presented by the Governor of Bank Indonesia, Soedradjad Djiwandono, at the annual bankers' meeting in Jakarta on Jan. 19, 1995. This is the first of a two-part article.
JAKARTA: The economic indicators point to strong economic growth in 1994, which reached about 7 percent. This is significantly higher than the 6 percent target for the first year of Repelita (Five-Year Development Plan) VI. Inflation, however, was registered at 9.24 percent, which was still above the Repelita VI target of 5 percent per annum, but slightly less than the year before. The current account deficit, though up by a small margin, remains within tolerable limits at about 2 percent of the GDP. Foreign reserves are quite ample, having increased during 1994, and are now sufficient to pay for around five months of imports. What are then, the factors that have brought about this heartening macroeconomic performance?
On the domestic front, the economic recovery that began in mid 1993 continued through 1994. Growth in private investment strengthen while growth in private consumption remained strong. The remarkable upswing in foreign and domestic investment approvals is an indication of just how keen investors are. It is also a reflection of the strong confidence of domestic and foreign business community in Indonesia's economic prospects. A key factor in this success story is the 1994 deregulation in the real sector, which opened the doors considerably wider to investment. This went hand-in-hand with government efforts to maintain a stable business climate through the consistent application of prudent fiscal and monetary policies. These factors have converged to generate stronger economic activity in almost all sectors, with manufacturing and construction in the lead. Dynamic and robust economic activity has increased the incomes, and this in turn has fostered greater consumption. Last year we witnessed a strong upturn in market demand for a broad range of consumer goods.
Our economic growth has also been driven by strong external demand. In 1994, the economic recovery gathered pace in the industrialized countries including the United States and some European countries, and in some countries with have strong trade relations with Indonesia, such as ASEAN and East Asia. The worldwide economic recovery has not only provided a generous boost to world trade, but has also increased prices of several agricultural and mining products. Oil prices, which had declined since 1993, began to rise in the second quarter of 1994.
However, relatively high economic growth in the United States and the UK has encouraged their central banks to raise interest rates in an effort to reduce the threat of inflation. As you all well aware, the Federal Reserve raised the Fed Funds rate several times in 1994 to curb inflation. In one year, the Fed Funds rate went up from 3 percent to 5.5 percent. This has generally had repercussions on interest rates the world over. Ladies and gentlemen,
One interesting point I would like to mention about Indonesia's economic growth last year was that domestic forces came to the fore. There was a surge in consumer and business demand for a wide range of goods and services, which put upward pressure on domestic prices. Another indication of these forces was the pressure on the current account, as the demand encouraged imports to grow at a faster rate than exports.
Rising inflation rate in 1994 was associated with difficulties in the supply of some strategic goods. Food prices, and particularly rice, went up because of higher floor prices for unhusked rice and fertilizers introduced early in 1994. Harvest failures in some provinces as a result of the prolonged dry season pushed prices even higher. An added factor was the improvement in world market prices for some of our export commodities, such as palm oil and coffee. This apparently had some effect on domestic food prices. Another significant component in inflation was higher housing prices, reflected in the rising prices of cement, bricks, wood and other building materials. This sharp increase fueled by the robust growth in the construction sector.
Confronted by these situations, the government responded by adopting measures designed to strengthen supply and curb demand. On the supply side, the government reinforced supplies of those commodities by the market operation by Bulog. To control demand for goods and services, monetary policy was adjusted to hold liquidity in the economy at the appropriate level to sustain ongoing economic activities.
Growth in the money supply and domestic liquidity were kept within appropriate level. According to the latest available figures, I can say that money supply (M1) grew by 23,2 percent in 1994, while economic liquidity (M2) grew by 19,7percent. Bank lending also behaved in a similar manner, rising by a reasonable 23,1 percent.
As to be expected with the upswing in economic activity, there was a perceptibly strong demand for credit from the business community and the public. However, growth in bank deposits has lagged behind the expansion in credit. This gap between the sources of funds and credit has pushed up domestic interest rates in recent months. Another key factor was also the upward movement in international rates, particularly U.S. interest rates. Of course, in the present climate of deregulation, Bank Indonesia no longer sets bank interest rates. It is the banks themselves that determine deposit and lending rates as they see fit according to market conditions and prospects. However, I would like to emphasize at this point that Bank Indonesia will not remain idle if broader interests such as economic and monetary stability are threatened. Adjustment of interest rates according to changes in economic fundamentals is something that banks can and obviously must do. However, if banks hike rates unreasonably or do so simply to jump on a bandwagon, their actions will undermine the market and will not be consistent with our economic interest. In the end, the banking system itself would also suffer. Therefore, we should not allow such things to happen.
Banks should plan their commitments on extending credit according to their ability to raise deposits, and thus keep credit and funds in reasonable proportion. Therefore, in 1995 part of Bank Indonesia's tasks as the monetary authority will be to keep a vigilant eye on bank funds and credit commitments. In particular, we will be monitoring the way in which funds and credit commitments are managed, and how banks maintain a proper balance between the two from the standpoint of prudential principles and sound bank management.
In early 1994, our economy once again suffered a setback as the speculative outflow of dollars sparked by rumors of an impending devaluation of the Rupiah or similar drastic action. Such rumors flare up from time to time, often from unidentifiable sources. Unfortunately, it often happens that many people, including sophisticated citizens, believe these reports causing them to behave in a less rational manner. Sometimes such rumors originated from foreign sources based on their forecast on our economy which are often not based on accurate information. These rumors are fanned when one or more indicators of our economic performance provides a more pessimistic picture than had been expected.
In the first few months of last year, there were some discouraging developments. Oil prices were weakening, non oil-gas exports were not growing with the same vigor as in the year before, and inflation was rising. There was an announcement that the Budget run a deficit that would have to be covered by Development Budget Reserves (CAP). Things took on a more discouraging tone when worker unrest and demonstrations took place in several regions. In some regions, there was a disruption of public order and normal economic activities. The fact that these various events all occurred around the same time lent some credence to these devaluation rumors. The result was a massive dollar buying spree that began in mid-February. When it started, the amounts involved were not high, but shortly thereafter dollar buying took off forcefully and turned into capital flight. The situation did not let up until June 1994. Public behavior returned to normal after the rumored events failed to materialize. In August 1994, there were signs that capital had begun to flow back into the country, and many began to sell their foreign currency holdings to Bank Indonesia. On this occasion I would like to confirm the stance taken by the government and Bank Indonesia as well-that we decided to counter the rumors. Past experience have shown that we were able to manage such rumors owing, of course, to the actual condition of our economy.
At various occasions in the past I have also said that we have succeeded in reducing our dependence on oil revenues. The rupiah exchange rate is now no longer closely linked to changes in oil prices. About 76 percent of our exports are comprised of non oil- gas products. A much smaller proportion of government revenues come from oil and gas taxes. About 78 percent of total domestic revenues now come from non-oil sources. Given these factors, there should be little cause for alarm over the impact of a drop in oil prices for government revenues or the balance of payments. I think that it is time for our people to display greater confidence on our macroeconomic management and not be so easily taken in by either local or foreign rumors attempting to link devaluation to flagging oil prices.
The overall balance of payments for 1994 remained strong, despite some discouraging developments in the first half of the year. Oil exports, which had weakened in the early part of the year, began to pick up in the second quarter. Non-oil exports, which had also shown signs of stagnation, embarked on a recovery in the second quarter, among others, because the prices of our commodities increased. Increasing domestic demand led to sharp rise in imports. The current account deficit posted about US$ 1.8 billion in the first quarter of 1994, and then subsided to US$ 1.5 billion in the second quarter.
As regards the exchange rate, Bank Indonesia has consistently implemented a managed float to maintain a realistic exchange rate for foreign trade and domestic monetary management. Bank Indonesia has also amended regulations to stimulate the foreign exchange market and provide money market players with greater room for trading. We have increased the spread between the dollar buying and selling rates from Rp 20 to Rp 30, and introduced new regulations for the net open position.
It is worth noting that the wave of dollar speculation had no major impact on foreign reserves. The outflow took place during a period of high foreign exchange earnings from oil exports and also strong inflows from the government's offshore borrowing. Bank Indonesia had also anticipated this capital outflow and prepared itself through prudent management of foreign reserves which accumulated during the high inflows that occurred close to the end of 1993. In fact, there was no heavy pressure either on balance of payments or government revenues. With all these ups and down, the year ended with foreign reserves up at US$ 13.2 billion at the end of 1994, sufficient to cover five months of imports.
In 1994 we also posted considerable progress in the banking system. Since Pakmei (May deregulatory package) 1993, banks have been busy with consolidation to bring themselves into line with the new regulations. These essentially comprise regulations for the implementation of Act No.7 of 1992 concerning Banking. Growth in banking activities and compliance with the prudential regulations over the past year shows that banks have managed the consolidation process well.
At the end of September 1994, compliance with the Capital Adequacy Ratio (CAR) was 92.9 percent for all categories of banks. Only 4.6 percent of all banks had a CAR of less than 5.0 percent. Banks have generally raised their CARs by increasing paid up capital. This is the most beneficial route to take for the long term survival and growth of the bank.
Bank's balance sheet strengthened in 1994, as shown by various key indicators, including the capital assets ratio, which registered an improvement over the previous year. The improved performance is consistent with the fact that more banks have complied with the CAR, as I mentioned earlier.
Another encouraging development in our banking system is the improvement in the quality of credit. Collectibility has improved with the proportion of credit rated as current on the rise, while sub-standard and doubtful credit is on the decline. Although problem loans have subsided, stronger efforts to resolve them should get top priority. The general improvement in the collectibility of earning assets is also reflected in other indicators, as shown by improved profitability related to higher return on assets (ROA) and return on equity (ROE).
In the era of development, our domestic banking system also bears a responsibility to promote equity. In order to support equity in development, last year banks achieved considerable progress in extending credit for small-scale enterprises. About 26 percent of total bank lending is now comprised of small-scale enterprise credit. Added to this, Bank Indonesia has identified many potential projects that deserve finance with small-scale enterprise credit. The identified projects are now either in the pre-feasibility study or feasibility study stage, and include "core-plasma" partnerships in all sectors. To further promote rural economic growth, I suggest that commercial banks continue to expand their cooperation with rural banks in order to promote further small-scale enterprise credit, as rural banks generally work closely with the small-scale business, and these entities have achieved strong growth.
Similarly, we should continue working together on developing the Bank Low-Income Group Linkage Program (PHBK). This scheme is designed to provide low-income groups with access to banks services. The program offers a solution for some groups that previously had trouble gaining access to banking services. Measures designed to promote small-scale business and development among low income groups will be of tremendous benefit to the poverty alleviation program, which has become an important Government concern that we are committed to overcome during the Second Long Term Development period.
Besides the progress achieved, we also have to admit that our banking system still faces significant challenges. One of these is the need to improve banks' internal control. Recent experiences have shown that the existing problems of our banking industry were caused by the banks' weak internal control. As I have mentioned briefly, collusion and fictitious exports have recently been in the limelight. These issues pose a challenge for the banking system to put its house in order, and improve administration and internal control. As for the issue of fictitious exports, although the banks' role is limited to checking that all the required documents exist and are valid, more is now asked of the banks to detect fraudulent practices that might occur in the international trade. There is a greater possibility of fictitious exports if there is collusion between exporters and banks' officials. Collusion is a problem that concern the morals and integrity of the persons involved. If it takes place within the banking system, it could have devastating repercussions for the bank involved.
In addition, I would also like remind you that we all need to pay attention to the issue of compliance with the legal lending limit. Although more and more banks have complied with the legal lending limit, there are still many that have not. As we are all aware from our experience in recent year, a large proportion of problem loans and other bank difficulties have their origin in the violation of the legal lending limit. The legal lending limit or similar regulations is universal and exist in many countries, as this regulation is a strategic concept in assuring the soundness of the banking system. Compliance with the legal lending limit will make it possible to build a healthier banking system. Another reason for the legal lending limit in our country is to promote more equitable development by allowing more people to have access to credit. For these reasons, the government is very serious about enforcing the legal lending limit, and Bank Indonesia will closely monitor.
As we know, last year was marked by strong credit expansion. Looking at the issue on a sectoral basis, there has been very rapid growth in credit for services, which has been fueled by a strong surge in lending for construction and housing, including real estate projects. We all need to pay attention to this area, as any over-concentration of credit in one activity or business group may increase the bank's exposure. This is especially valid in the case of property, which as shown by the experience of many countries to be highly susceptible to market saturation. I would like to emphasize again that the array of risks not only has potential repercussions at the level of the individual bank, but also has a systemic impact on the banking community as well as monetary stability.
To create the sound, efficient and competitive banking system that we all desire, we all have to work harder to deal with problem loans and improve the general quality of bank portfolios. Regarding problem loans, Bank Indonesia is working on strengthening measures that it has already introduced. These measures cover three main areas. First, there is assistance for banks in dealing with their existing problem loans. Second, we will take preventive measures to limit the occurrence of new problem loans. Third, we are going to provide guidance and supervision for banks in trouble due to problem loans. To speed up the settlement of problem loans, there is more work that needs to be done to improve the effectiveness of the legal system. Bank Indonesia has been working with the agencies that are involved in this area, such as the Supreme Court, the Ministry of Justice, the Attorney General Office, the Ministry of Finance, the National Land Agency, and the Agency for Settlement of Government Claims, Further measures will also be adopted to strengthen this cooperation.
Measures adopted to deal with problem loans through State Bank Credit Supervision Teams (TSKBP) at state banks and Special Units (STK) at private banks will be further reinforced. In the case of private banks, the Special Working Team at Bank Indonesia, whose task is to monitor the Special Units at the bank level, will also be strengthened. These measures are expected to enable banks to overcome their problem loans, and will also improve the monitoring of this process. Furthermore, Bank Indonesia is also working with other agencies on the possibility of establishing a Credit Subrogation Agency for handling problem loans at state banks. Bank Indonesia is also looking into the possibilities for phased write-offs of bad debt from the private banks' balance sheet.
Of course, it is also necessary to prevent new problem loans, and in this area Bank Indonesia has redesigned Credit Policy Guidelines (PPKP), updated the credit information system and bad- debt list, and improved the internal audit function. Bank Indonesia also requires banks to provide a working plan for the bank and a report from the Board of Commissioners on lending to debtors affiliated with the owners or management of the bank. Similar reports are also required on lending to large debtors. Furthermore, Bank Indonesia will soon issue the criteria for banning persons from becoming shareholders in banks or members of the board of directors. These criteria are expected to helps banks in keeping out people whose involvement could threaten soundness or even survival of the bank.