The spectre of inflation

The spectre of inflation

Bank Indonesia's move on Monday to nearly double the interest
rates on its benchmark instruments (SBI) to a range of 40 percent
to 45 percent for papers of one week to two months should have
been the best of the worst alternatives it has in addressing the
threat of inflation and arresting the rupiah's fall. The
immediate consequence, though, is that a lot more businesses may
have to fold.

The SBI rate increase is obviously designed to soak up excess
liquidity that is threatening to increase inflationary pressures.
The central bank said M1 -- currency and demand deposits --
expanded by 12.15 percent last December, and by 18.45 percent in
January, to reach Rp 92.8 trillion, before declining slightly to
Rp 92.5 trillion in February. M2 (M1 plus savings, time deposits
and other quasi money) also rose sharply by 7.6 percent in
December and 26.73 percent in January to reach Rp 450.7 trillion,
but decreased to Rp 430.2 trillion in February.

The anomaly here is that most national banks are cash
strapped. The central bank's governor, Sjahril Sabirin,
acknowledged Monday that Bank Indonesia had been forced to pump
cash into banks. As many big depositors cashed out of private
national banks immediately after the November closure of 16
ailing banks, most local banks would not have stayed afloat
without liquidity injection from the central bank.

The problem now is that people are not spending. Nor are they
putting money in many local banks, which they consider too risky.
Many depositors have moved their savings to foreign banks in
Jakarta or overseas, especially in the wake of anti-Chinese riots
in January and February. A lot of money is not circulating, but
is kept instead in safe-deposit boxes, tucked under mattresses
and crammed into holes in the floor.

Bank Indonesia is indeed caught in a precarious dilemma
because of the blanket guarantee it has provided for rupiah and
foreign exchange claims on all locally chartered commercial banks
since January. If it stops supporting the banks, most of them are
likely to collapse, undermining further the already sagging
confidence in the banking sector. If, however, it keeps injecting
cash, it risks worsening inflation, projected at a range of 40
percent to 50 percent for this year -- inflation in the first two
months already reaching almost 20 percent -- especially because
the government's decision to continue food, fuel and electricity
subsidies will require the central bank to print more money this
year.

Pumping money into ailing banks, including grossly
inefficient ones, is also against the banking reforms already
agreed on with the International Monetary Fund (IMF).

Basically, Bank Indonesia is just buying time and delaying
bankruptcies, which will only serve to hinder the progress of
banking reforms. Which leaves us wondering what has been done by
the Indonesian Bank Restructuring Agency (IBRA) whose former
chief, Bambang Subianto -- known for his tough stance on ailing
banks irrespective of the political backing of their shareholders
-- was fired last month after less than two months in that post.

As local banks can now increase their deposit rates to as
high as 65 percent (150 percent as high as the SBI rates), they
hopefully will be able to lure back a hefty portion of the money
now outside the banking industry. Foreign banks, currently awash
in liquidity but averse to lending to national banks, may also be
attracted to put their excess liquidity into SBIs.

Nonetheless, Bank Indonesia cannot maintain such prohibitively
high interest rates for some time without crippling economic
activities. This means the IBRA should speed up the
implementation of banking reforms in order to restore public
confidence in the national banking industry.