Central bank's focus should be on growth

The Jakarta Post ,  Jakarta   |  Mon, 07/10/2006 5:08 PM  |  Opinion

Winarno Zain, Jakarta

Now that the puzzling game of predicting the move by the Federal Reserve on its interest rates is over, Bank Indonesia (BI) should be able to set its sights on the future of the Indonesian economy. Instead of responding to the short-term movement of global interest rates, BI should start concentrating on issues of how it is going to use its monetary policy to spur further economic growth.

The growth of the Indonesian economy has been decelerating at a worrying speed from 6.2 percent in March 2005 to 4.9 percent in December and to 4.6 percent through March this year. Manufacturing industries, the biggest component of the nation's GDP and the biggest source of employment suffered the worst beating as its growth collapsed from 7 percent in March 2005 to only 2 percent in March this year.

Worried about high inflation rates that jumped from 9.1 percent in September 2005 on a year-on-year basis to 15.6 percent in May, due to the doubling of fuel prices, BI is forced to maintain its tight monetary policies, despite some recent pronouncement by the central bank governor that there was room for reducing rates.

But this overly cautious stance on inflation might seem to be unwarranted. The inflation that we are facing is the cost-push kind of inflation coupled with bottlenecks in distribution. It is not a demand-pull kind of inflation, since there is no excess demand where using tight monetary policies is more appropriate.

There is concern that if BI cuts its key rates, the market would respond negatively. But events in the past few weeks showed that the market gave a positive response, in the form of rising share prices and strengthening of the rupiah, every time BI announces its intention to cut the rate. When the opportunity for BI to cut its rates opened wider last week after the Fed announced its dovish stance on interest rates, the Jakarta share price index soared, surpassing the 1,300 level and the rupiah strengthened.

Moreover inflation has been so moderate this year, due to sluggish demand.. For the first five months inflation was 2.4 percent, meaning we could really expect an inflation rate of 6-7 percent for the whole of 2006.

Besides, if inflation starts picking up again, raising the interest rate is not the only option. There are of course other means to contain inflation. One of them is controlling base money. Unfortunately, BI's record in controlling base money is not convincing.

In recent months, money in circulation has been growing rather fast. After growing at 20.2 percent in December 2005, it grew at annual rates of 26.6 percent in January 2006 and at 27.9 percent in March 2006 although the Idul Fitri and New Year season was long over.

The other instrument for containing inflation requires coordination with the government, as this is beyond the scope of BI's responsibility. Indonesian inflation is weighted heavily toward the food price index. An increase in rice prices has a large influence on inflation. The ban on rice imports is one of the reasons behind the rise in prices. Domestic rice production is still below consumption, so importing rice is still necessary to fill the gap. Moreover importing rice is needed to lower its prices.

Because of the import ban on rice, millions of poor people around the country have suffered as they cannot afford to purchase rice at Rp 4,000 per kilogram. Millions of urban poor have either had to reduce their rice intake or substitute it with lower quality staple foods. Small farmers in Lampung and Yogjakarta have been reported to be eating tiwul (a kind of cassava), and millions of fishermen on the northern coast of Central Java have been reported to consume nasi aking (a kind of re-cooked dried rice).

But despite the plight of the poor, some local governments, backed by NGO's, in the name of defending farmers' interests, have closed their regions to imported rice. They don't know perhaps that out of 14 million farmer households, only one million have more than one hectare of land. The rest are small farmers who do not produce enough for themselves and who still need to buy rice from the market.

The truth is that poor people do not care whether the rice they eat comes from India or Indramayu, or whether it comes from China or Cianjur. For them the important thing is that they can eat rice at affordable prices. Lifting the ban on rice imports would make it cheaper, thereby easing the burden of the poor. It also would lower inflation and would reduce BI's burden in steering interest rates .

For BI, accelerating growth should be more important than the narrow objective of containing inflation since it is related to the broader objective of improving the welfare of millions of people who are unemployed and living below the poverty line.

Meanwhile the government has been taking actions to improve the investment climate in order to revive investment. The packages involve a wide range of measures, including improving legal certainty in investment, simplifying bureaucratic procedures, reform on taxation and customs, revising the current Labor Law, and a comprehensive plan to build infrastructure.

Although the government has implemented some of the reform agenda, the list of the packages that have to be completed remain a tall order for the government, given the weaknesses in its bureaucracy.

Investment is expected to recover in the second half of 2006 especially when the government has been able to address the problems of bureaucratic snags in the disbursement of its development budget. But the pick up in investment would be faster if it is supported by appropriate monetary policies from BI.

A more flexible monetary policy from BI would send signals to the market that the government is serious about accelerating economic growth. More accommodating policies from BI and lower financing costs for businesses should go hand in hand with the implementation of investment packages by the government.

Of course there would be risks that a looser monetary policy would result in capital outflow as it reduces the spread between domestic interest rates and international rates. But the confidence from the market that results from better a investment climate should more than offset the adverse effect of looser monetary policies.

The writer is a Jakarta-based economic analyst. He can be reached at winarno_zain@yahoo.com.sg.

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