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.