Tight money hits stock

Tight money hits stock

Last Thursday's 3.13 percent fall in share prices in Jakarta
-- the steepest slide in one day's trading after the almost 5
percent plunge on July 29 last year as the impact of major riots
in the capital -- once again told of the difficult choices the
monetary authorities often have to make in coping with economic
problems while managing the competing objectives of the various
sectors of the economy. As the biggest problem being encountered
since July 21 was the persistent, if irrational, speculative
attacks on the rupiah, credit crunch seemed to be the most
effective measure to produce an immediate result. But this
measure, as widely predicted, hurt the stock market.

Encouraging, though, was the central bank's consistency with
its commitment not to resort to any abrupt policy about-faces,
such as that by Thailand which created a two-tier currency market
and that by Malaysia which imposed restrictions on swap
transactions. Bank Indonesia tightened the money supply through
open-market operations: raising the rates of its short-term
certificates early last week to soak liquidity from the market
and at the same time stayed out of the short-term money market
securities. Consequently, interbank rates surged, forcing many
banks to increase deposit rates in order to attract new funds.

But the credit crunch is inimical to the stock market because
high interest rates usually create a bearish sentiment on equity
investors. The tight monetary measure hit the stock market in two
major ways. One was the pull factor whereby the higher yields
(interest rates) offered by the short-term money market lured
funds out of the stock exchange. The other was the push factor
whereby higher interest rates were feared to decrease corporate
profits.

Though most analysts still saw the Aug.7 fall in the Jakarta
Stock Exchange's composite index as too steep, especially because
the monetary authorities had assured the business community that
the credit crunch was only an ad hoc measure to discourage
currency speculations. True to its promise, Bank Indonesia
lowered the rate of its seven-day certificates by 50 basis points
to 9.5 percent on Friday, though it maintained the rate of its
overnight certificates at 14 percent because the currency market
had not yet been firmly stabilized. Calm was immediately restored
to the market and another bloodbath was avoided on that day as
the composite index fell by only about 0.4 percent. But the
exchange suffered another significant price fall of 2.56 percent
yesterday on jitteries about the rupiah rate.

Even though the steep fall in the share prices could partly be
attributed to panic, the unusual slide seemed to point to
lingering jitters about the rupiah and the economic fundamentals
which support the currency rate. These inordinate worries seem to
signal that the market condition does not simply reflect the
spillovers of the attacks on the Thai baht and Philippine peso.

The adverse impact of the tighter monetary measure on the
liquidity in the banking sector seemed to strengthen analysts'
suspicions that the condition of many banks might not be as sound
as their published balance sheets show. Recent media reports on
scandals at several banks, though a very small number compared to
the total 237 banks in the country, could add to the lingering
worries.

It is therefore imperative that the central bank acts firmly,
quickly and transparently to solve the problem of ailing banks
before the situation worsens to the same extent which set off the
banking crisis in Thailand. Experiences in Mexico in late 1994
and now Thailand, both categorized as emerging markets, show that
a banking crisis was the trigger of a currency fiasco with all
its adverse implications on the macroeconomic condition.