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elatively high interest rates have had a negative impact on Indonesia's finance industry.

Bank Indonesia (BI) has cut its benchmark rate 150 basis points since December 2008 but because of tight liquidity and the increased uncertainties surrounding the economy, the banking sector has been slow to cut lending rates.

The finance industry started to slow down in November 2008 as many finance companies took a more cautious stance in regard to providing new financing.

In the fourth quarter of 2008 and the first quarter of 2009, major finance companies decided to raise their financing rates, increased the amount of the required down-payment, and became more active in debt collection.

The major players have learned from the industry downturn in 2005 that reducing down payments in the face of stiff competition was a mistake. The danger is that non performing loans (NPLs) will increase. And this is what happened in 2006 when they rose to around 3 percent from around 2 percent in the previous year.

As a result of the more conservative approach adopted by the major finance companies in the last quarter of 2008, NPLs were kept down to an estimated 1.78 percent as of the end of the year. This compares to a level of 2.05 percent at the end of 2007. This is encouraging and indicates an improvement in asset quality in the finance industry.

Nonetheless, growing concerns on the economic front are likely to discourage finance companies from adopting aggressive expansion plans until the economic prospects look brighter. For 2009, we expect a modest increase in NPLs to a maximum of 3 percent.

After the last BI rate cut to 8.25 percent in early February 2009, some major players have reduced their financing rates by around 1-2 percent. As such, a positive impact on car and motorcycle sales is expected to be seen in February.

Whether the downtrend in car sales - which began in August 2008 - and in motorcycle sales - which began in September 2008 - will end remains to be seen, but lower financing rates should help give some impetus to sales. Nonetheless, for the full year of 2009, motorcycle and car sales are still expected to be lower than in 2008 (by around 30 percent lower, by our estimates).

The year 2008 was actually a record year for auto sales.

In 2008, the domestic automotive industry grew by almost 40 percent, with more than half of the domestic car sales made by Astra, Indonesia's largest automotive company.

The motorcycle industry, meanwhile, grew 32.6 percent in 2008, demonstrating the attractiveness of motorcycles given their affordability and because of the poor quality of the country's public transportation.

With auto sales high, 2008 was also a good year for Indonesia's financing industry. Indeed, some 60.6 percent of the overall outstanding financing in 2008 was from auto loans. At the end of 2008, the outstanding financing reached Rp 137.24 trillion, or up 27.4 percent from Rp 107.69 trillion at the end of 2007.

The commodity boom in the last few years also drove growth in the finance industry, primarily for the leasing of heavy equipment. And although the commodity boom came to an abrupt end in the second half of 2008, growth in leasing reached 38.9 percent in 2008, higher than the 11.76 percent growth in 2007.

Overall, leasing accounted for 36.9 percent of the total outstanding financing in 2008, up from 33.9 percent in 2007.

In contrast, there was little growth from either factoring or the credit cards segment in 2008. Indeed, factoring only grew by 0.95 percent while the credit cards segment shrank 20.6 percent.

These two segments are also small in size and accounted for only 2 percent and 1 percent of total outstanding financing, respectively, in 2008.

It is still the case that these two businesses are predominantly undertaken by the banking industry rather than the finance industry.

It is expected that the main driver for the finance industry in 2009 will be consumer financing, with most of the financing provided for motorcycles and cars.

However, as sales of motorcycles and cars are expected to decline by around 30 percent in 2009, growth in outstanding financing is expected to be flat.

However, there are still some reasons to remain fairly upbeat.

First, motorcycles are a very popular mode of transportation in Indonesia. Not only are they cheap to maintain and run, but they are also preferred by many to the country's dilapidated and inefficient public transportation. Thus, provided that the average income per capita holds up, demand for motorcycles should remain relatively firm.

Secondly, from a macroeconomic perspective, inflation is expected to fall in 2009. This should mean lower interest rates, thus resulting in a lower cost of borrowing and therefore stronger demand for consumer products purchased on credit.

And from the supply side, it should be noted that the financing business still enjoys relatively high margins.

This means that the way should still be open for finance companies to attract investors to fund their operations. In this regard, three finance companies have plans to issue bonds in the first quarter of 2009.

Better liquidity and hopes of further cuts in interest rates, meanwhile, should allow finance companies to reduce their financing rates in the second quarter of 2009.

Another positive is that finance companies have learnt their lessons and are now more capable in managing their NPLs by implementing prudent risk management strategies.

In conclusion, this year will definitely be a challenging one for the finance industry due to heightened uncertainties on the macroeconomic front. As such, finance companies have little choice but to take a cautious stance.

Also, if the global economic crisis is prolonged, then there is the risk that the outstanding financing of the industry sees a decline rather than stays flat this year.

However, reasons for optimism remain. And if liquidity improves and interest rates continue to decline, then the finance industry may show further growth this year.