Banking sector problems could undermine macro recovery: BI

Urip Hudiono, The Jakarta Post, Jakarta

The central bank sees Indonesia's economy picking up further next year as both inflation and interest rates continue their downward trend, but warned that problems in the banking sector could undermine all the recent gains in macroeconomic stability.

Growth "will continue rising to at least 6 percent in 2007" with inflation "having the prospect of coming in at between five and seven percent," Bank Indonesia Senior Deputy Governor Miranda S. Goeltom said Wednesday at a seminar.

BI's Board of Governors said in a statement later in the day that Indonesia's economy may expand within a range of 5.7 percent to 6.3 percent in 2007 on increases in both private and public-sector spending, exports and investment by the second half of the year.

Growth could reach the upper range if such downside risks as a mismatch in supply and demand, lending problems in the banking sector and global economic risks were addressed from the outset.

The government is expecting growth next year of 6.3 percent -- up from this year's estimate of 5.8 percent -- and inflation of 6.5 percent -- down from 2006's estimate of 8 percent.

Indonesia's economy grew by 5.5 percent in the year to the end of September on higher consumer spending and a continued strong export performance. Inflation slowed to an on-year rate of 6.3 percent in October from 17 percent earlier in the year, which helped improve people's purchasing power.

Miranda said the economy would continue to pace up as inflation eased, possible coming in at the lower range of BI's estimate at slightly under 6 percent.

The current stability of the rupiah would help contain inflation, she said, despite possible inflationary pressures in early 2007 as a result of the government's plan to raise civil service salaries. Other inflationary pressures could arise from higher global oil prices over the course of the year.

The central bank would also continue to adjust its benchmark BI rate in line with inflation, but would strive to maintain a balance so as to support growth.

By the beginning of November, BI had cut its key rate by 2.5 percentage points to 10.25 percent from 12.75 percent earlier in the year. This should help push down lending rates, thus encouraging higher business and consumer lending.

Yet therein lies the dilemma, Miranda said, with the banking sector still facing non-performing-loan (NPL) problems, thus discouraging lenders from increasing lending.

"It is therefore essential that the NPL problem is solved," she said.

"If it is addressed, then more loans can be disbursed, thus avoiding excess liquidity in the banking sector."

BI might have to raise its key rate again, Miranda warned, to absorb this excess liquidity through treasury bills and government bonds.

This could undermine the macroeconomic improvements that have been achieved so far. If the banks were to invest their excess liquidity in treasury bills and government bonds instead of loans, this will contribute almost nothing to economic growth.

Miranda therefore urged banks to further improve efficiency and the prudent management of loans.

The central bank noted that lending increasing by Rp 18.5 trillion (US$2 billion) in September from Rp 10 trillion the previous month.

While this will be enough for the industry to achieve lending growth of 13 percent this year, it still falls far short of the previous target of 18 percent. Lending growth is only expected to recover to between 15 and 18 percent next year.
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