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No. 9/ 8 /PSHM/Humas
On Tuesday 6 February 2007, the Board of Governor’s Meeting at Bank Indonesia (BI) decided to lower the BI Rate by a further 25 bps from 9.50% to 9.25%. This decision was taken after an evaluation of Indonesia's macroeconomic conditions as of end-January 2007, the economic and monetary outlook, various risks ahead and progress towards the inflation target, set at 6%±+1% and 5%±1% for 2007 and 2008. “The risks assessed in the Board of Governors' Meeting indicate that room for further reduction in the BI Rate, if any remains, will become narrower and more restricted," explained Governor of Bank Indonesia Burhanuddin Abdullah.
In the assessment of the Board of Governors’ Meeting, the national economy is still on track with beginning of year forecasts and opportunity remains for higher growth. Indications of improvement in economic activity include early signs of a rise in investor interest, more positive business perceptions, higher imports of capital goods, stronger sales and reductions in inventories. Nevertheless, the supply-side response remains constrained in the areas of capacity expansion (due to problems with infrastructure, energy and the investment climate) and improvements in efficiency and productivity (due to high costs within the economy, low level of skills worker and steady decline in productive life of capital).
The continued high micro-structural risks that beset the economy in the real sector have begun to constrict the window of opportunity for public policy decision makers. At the same time, there is less and less room for further reduction in the BI Rate. “For these reasons, efforts to sustain the momentum for economic recovery through faster action to bring about tangible improvements in the investment climate, reductions in excessive costs and resolution of other structural distortions will be of crucial importance during the first half of 2007. Bank Indonesia will also proceed more carefully in the timing and magnitude of changes in the BI Rate to maintain the existing price and exchange rate stability, both fundamental requirements for more robust economic growth," added Burhanuddin.
As of January 2007, price and exchange rate stability was well in hand. Inflation in January 2007 reached 6.26% (y-o-y), down from 6.6% (y-o-y) at the end of 2006. Core inflation in January 2007 was little changed from December 2006 at 6.05% (y-o-y). The Rupiah maintained its appreciating trend, reaching Rp 9,070/USD while recording only modest volatility. Continued heavy capital inflows for portfolio investments supported this appreciating trend.
The Board of Governors’ Meeting notes a number of risks ahead that call for careful consideration: First, various issues persist that could potentially lock in the supply-side rigidities for the rest of 2007. These stem mainly from the high cost economy, conflicting and inconsistent regulations, charges seen as excessively burdensome to business and poor legal certainty. The Board of Governors’ Meeting also takes note of the lack of improvement in capacity for accelerating development spending in the regions. All of these issues are perceived by business in the real sector as high micro-structural risks in the economy, and as a result have dampened business interest in investment for capacity expansion. The impact of supply-side rigidities means that the real sector economy is unable to absorb the excess liquidity on financial markets. In addition, any demand-side stimulus and policies for boosting liquidity within the economy will create a tendency towards overheating and excessive inflation, which could lead to collapse in the macroeconomic stability that forms the basis for higher economic growth.
The various measures pursued by BI to promote bank lending have shown some heartening results, as reflected in the significant credit expansion recorded in the final months of 2006. Looking ahead, success in achieving the targeted credit expansion of 18% in 2007 will not only depend on Bank Indonesia’s various policies for relaxation of prudential banking regulations, but more importantly, by the magnitude of micro-structural risks in the economy. Although further changes are possible, there will be less leeway for relaxation measures.
Second, the massive flooding that has brought economic activity in Jakarta to a halt at the end of the current rainy season may have a significant first-round effect on prices. “BI will maintain a close watch for the second-round effect on inflation expectations in coming months and the impact of the flooding in Jakarta on real sector economic activity," added Burhanuddin.
Third, the Board of Governors’ Meeting notes that the Bank Indonesia inflation projection for the two coming years, i.e. 2007 and 2008, is tending towards the upper limit of the inflation target. At the same time, the present trend in core inflation, which is an early predictor of CPI inflation in the medium and long-term, similarly points to a persistently high figure.
Overall conditions in the banking industry steadily improved during 2006, as reflected in positive trends in key banking performance indicators. In 2006, total assets mounted by Rp 223.7 trillion or 15.2%. The capital adequacy ratio (CAR) also strengthened from 19.5% to 20.5%. On the other hand, the banking industry still confronts the key issues of inadequate performance in the bank intermediary function and action to reduce problem loans. While banks accumulated Rp 223.7 trillion in additional assets in 2006, only Rp 102.8 trillion of these funds were channelled into loans. The remaining Rp 110.3 trillion was invested in securities (SBIs and FASBI). During the same period, NPLs dropped significantly to 7.0% (gross) and 3.6% (net) from the December 2005 position of 8.3% (gross) and 4.8% (net).
Source: Bank Indonesia
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