Soedradjad's caution

Soedradjad's caution

The likely success in checking the inflation rate at less than
7 percent this year, compared to 8.65 percent last year, should
not create too high expectations among businessmen of a
significant easing of the tight monetary policy. Bank Indonesia's
Governor Soedradjad Djiwandono, instead of hinting at the
possibility of a relaxed monetary stance in the near future, has
reasserted the imperative for both fiscal and monetary
conservatism.

Soedradjad told participants at a seminar on the economic
prospects in 1997 Tuesday that the situation had not yet become
solidly stable to allow for a substantial easing of the monetary
policy. The economic overheating, though already starting to cool
down, remains highly vulnerable to inflationary pressures. The
main reason is that the economic growth has been fueled mainly by
the domestic market demand, and not by export expansion.

The central bank governor seems to be afraid that a
substantial easing of the monetary policy now could trigger a new
wave of inflationary pressures. This, combined with the big
deficit in the current account of the balance of payments, could
lead to a devastating instability. Soedradjad was also not
greatly optimistic about the ability of exports to regain their
previous robust growth of more than 17 percent a year.

Soedradjad seemed still uncomfortable with the developments in
the monetary aggregates. The money supply (narrowly-defined) has
been expanding by an annual rate of 27.5 percent, much higher
than the target of 15 percent, as has been the economic
liquidity, with a growth rate of 26.1 percent, as against the
target of 17 percent. Lendings by the banking industry, even
though still groaning under a large amount of bad credits,
continue to increase at an annual rate of 19.8 percent, compared
to the target of 16 percent.

But two additional policy instruments (prudential rulings) are
already in place to exact a contractive impact on lending growth
next year. Banks will have to increase their compulsory reserve
requirement at the central bank from 3 percent now to 5 percent (
of third-party deposits) beginning in the middle of April. Banks
will also have to increase their capital adequacy ratio from 8
percent now to 9 percent beginning in September. That will force
banks to risk a larger amount of their own capital, and this in
turn is expected to pressure them to be more careful in their
lending operations. The higher capitalization standard will curb
their credit growth because they have to put up additional
capital in proportion to any increase in their credit expansion.

However, bank credits are not the only source of additional
liquidity to the economy. The large sum of the public sector's
spendings outside the state budget, which again came under strong
criticism from the House Budgetary Commission at a hearing with
the finance minister last week, is beyond Soedradjad's ability to
control. But the off-state budget spending, which will most
likely increase sharply next year as the dominant Golkar
political organization steps up the distribution of "political
goodies" in the run-up to the general election in May, will
certainly have a greatly expansive impact on the money supply.

Soedradjad predictably refrained from citing that political
factor in his analysis at the seminar, but we reckon he is fully
aware of its potential threat to the monetary stability and he
has inputted it into his monetary management.

The central bank is indeed facing a delicate task. As the
domestic interest rates will remain relatively much higher than
those overseas, the country will continue to be attractive to
short-term, speculative capital. However helpful this capital may
be to offset the current account deficit, that kind of capital is
highly vulnerable to rumors or political events which would
unavoidably increase before and after the election. Soedradjad
apparently wants to gear up for any developments.