Wednesday, March 07, 2007 Vincent Lingga, The Jakarta Post, Jakarta
The banks will publish their audited financial statements for 2006 within the next few weeks. The statements will mostly show bigger profits, but that doesn't mean the banks' managements should be commended for jobs well done.
The credit should instead go to Bank Indonesia, the nation's central bank, which had "been forced" to contribute more to banks' earnings.
Bank Indonesia Governor Burhanuddin Abdullah should indeed feel frustrated, since the new package of regulations he issued early last year to encourage bank lending has turned out to be ineffective. He should now work harder to soak up excess liquidity by issuing more Bank Indonesia Certificates (SBIs) and paying quite dearly for this instrument.
Even though many businesses are starved of finances, most major banks still prefer investing their excess funds in debt market instruments, notably risk-free SBIs and government bonds, instead of pumping them into the real economy.
It is unusual for a central bank governor to be so straightforward in airing a pessimistic outlook. But that was what Burhanuddin did last week. Apparently fed up with the slowness of the government's implementation of its reform policies, he sounded the alarm bell, warning of a weaker economy if banks remain inordinately risk-averse in their lending operations.
It is indeed a frustrating job for the central bank governor because, the more banks invest in SBIs, the higher the cost of Bank Indonesia's monetary market operations. He estimated the interest costs of SBIs this year alone at Rp 25 trillion.
While major banks pay only between seven to eight percent interest on time deposits, SBIs pay 9.25 percent. No wonder banks prefer investing their funds in SBIs. They can get more than 1.25 percentage points in interest revenue without doing anything. But investing in SBIs contributes nothing to economic growth.
As of last month, outstanding SBIs totaled almost Rp 240 trillion (US$25.8 billion). Burhanuddin estimated this amount could increase to over Rp 300 trillion by later this year if bank lending did not expand significantly.
The central bank governor certainly realized he could not jawbone commercial banks to expand their lending if business risks remain high and the overall investment climate remains highly adverse. Even the reduction of the central bank's benchmark short-term interest rate to 9 percent Tuesday will not be effective in prompting more lending.
It would be a suicide for banks to aggressively lend to businesses with unusually high risks, especially now the central bank is imposing higher standards of capital and overall credit risk management.
There is no a panacea to stimulate credit expansion. Bank lending cannot be accelerated by decree. The most effective way to stimulate bank lending is to improve the overall investment climate. Without significant improvements in the business climate the risk of bank credits turning sour will remain high.
Excess liquidity at banks is inflicting another cost on the economy. The huge sum of funds invested in SBIs and government bonds impose risks on macroeconomic stability. This is because idle money can immediately be used as ammunition for speculative attacks on the rupiah in the foreign exchange market.
Even more worrisome is the fact that, due to the unfavorable business climate, most foreign investment entering the country now consists of short-term portfolio capital. This hot money, currently estimated at nearly Rp 590 trillion, including Rp 505 trillion in stock holdings, Rp 55.5 trillion in government bonds and nearly Rp 25 trillion in SBIs, is another source of ammunition for speculative trading on the foreign exchange and stock markets.
The 3.5 percent decline in the Jakarta stock market composite index Monday had nothing to do with Indonesian economic fundamentals. The fall was due to changes in foreign investor sentiment caused by a perceived increase in the downside risk of the U.S. economy and a possible rise in Japan's interest rate.
This development is just more evidence that Indonesia's financial market and rupiah have become highly vulnerable to speculative attacks. This has been due to the steady increase in the amount of excess liquidity at the banks and in foreign portfolio capital inflows.
It should be needless to remind the government that the most effective way to push this excess liquidity into the real economy -- where it can finance the construction of factories and infrastructure -- is to reduce the country's high business risk by passing more reforms.
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