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.