Global stock market volatility has increased in the past couple of weeks led by the Chinese stock market. The Shanghai index collapsed as much as 25.5 percent since the yuan devaluation to its lowest level on Aug. 26.

On Aug. 24, the Shanghai index plunged 7.6 percent, the biggest one-day fall since 2007, and Chinese media called the day '€œBlack Monday'€. Similar to China, other emerging markets also suffered from the meltdown. Their currencies are plunging against the dollar, from the Indian rupee and Malaysian ringgit to the Brazilian lira.

In the domestic market, the rupiah depreciated significantly, surpassing Rp 14,000 per US dollar, a level not seen since 1998. The Jakarta Composite Index (JCI) fell by 13.8 percent from 4,802.5 at the end of July through 4,163.7 on Aug. 24, which was the lowest level since January 2014.

The global negative sentiment drove the foreign capital outflow from the Indonesian stock and bond market which reached Rp 10.3 trillion (US$60 million) last month, both in the equity and bonds markets.

The market'€™s sharp decline, especially the currency, has been one of Bank Indonesia'€™s (BI) biggest concerns. This is why the central bank has not cut the BI rate since February 2015 to manage the currency volatility. Monetary policy has been tight in the past 26 months, even though the central bank eased some of the macro prudential measures, such as requirements for loan to value (LTV) ratio for property and automotive segments. This was undertaken to anticipate a capital reversal, resulting from the uncertainties in the Chinese financial market and the US Federal Reserve funds rate hike.

National economic growth has fallen from 5.6 percent in the second quarter of 2013 to only 4.67 percent in the second quarter of 2015. It was the slowest economic growth since the third quarter of 2009.

In the banking sector, the industry struggled amid worsening performance because of the tight monetary policy and slowing economic growth. Loan growth has slowed significantly from 22.2 percent year-on-year (yoy) in July 2013, to only 10.4 percent yoy in May 2015. It was the slowest pace in more than five years. Rupiah loan growth was relatively flat at 10 percent yoy from 10.4 percent in the previous month.

Meanwhile, foreign exchange (forex) loans grew faster to 12.2 percent from 10.7 percent in the prevous month. But after adjusting to the rupiah depreciation, the forex loans actually contracted 1.4 percent compared to a year earlier. On the other hand, deposit growth was relatively stagnant at 12.4 percent yoy in May 2015. Demand deposit growth in May slowed to 10 percent yoy, from 12.9 percent yoy in the previous month and time deposit grew 19.5 percent yoy, slower compared to 22.3 percent in April.

Tight monetary policy and the slowing economy also lowered banking credit quality. Non-performing loans (NPL) had steadily increased from 1.87 percent in July 2013 to 2.58 percent in May 2015. The biggest contributors to the worsening credit quality were the construction sector, with an NPL level of 5.51 percent, and wholesale and retail trade (3.71 percent), up from 3.58 percent in the previous month.

Across the board, all types of NPL worsened. NPL of working capital loans in April rose to 2.86 percent from the previous month of 2.79 percent. At the same time NPL of investment and consumption loans rose to 2.72 percent and 1.63 percent from 2.58 percent and 1.59, respectively. NPL in those sectors need more attention because they have a large proportion of total Indonesian banking industry loans and relatively higher loan growth.

There are still risks of the increasing NPL in the upcoming months due to slowing domestic economic growth, volatile global economic condition and the weakening rupiah. Currently, Indonesian banks are less optimistic, as shown in the Indonesian Banking Survey in the second quarter of this year (2Q15). Respondents had cut the loan growth target rate to 12.2 percent. Even though it was higher than the loan growth in 2014, it was much lower compared to the previous target of 17.1 percent in the previous quarter.

Total net profit of the 10 biggest banks in Indonesia had contracted 18 percent yoy in the first half of 2015 because of the soaring provisions for loan losses. Total provisions of those top 10 banks in the second quarter of 2015 soared by 100.3 percent yoy. Loan-loss provisions of Bank Negara Indonesia (BNI) jumped almost 400 percent yoy, while loan-loss provisions of CIMB Niaga soared 261 percent yoy.

Going forward, we expect that the monetary policy stands will remain tight in the coming months as the risk of global market volatility is still high. A Fed official said that international developments have increased the downside risk to US economic growth, but the policy rate would still be increased this year, adding to the uncertainties of global conditions. This, together with the slowing domestic economy, would affect the performance of banking loan growth, NPL and profitability.

Overall, current economic and banking data is still much better than data from previous crisis periods. Even though the rupiah is at the lowest level since 1998, macroeconomic and banking indicators, such as gross domestic product (GDP) growth, inflation, foreign exchange reserves, NPL and capital adequacy ratio (CAR) are still much healthier compared to the period of crisis in 1998.

In 1998, the economy contracted more than 13 percent, inflation was 77.6 percent, foreign exchange reserves were only US$23.2 billion, banks'€™ NPL were 53 percent and their CAR was -15.7. Now, the latest data in 2Q15 showed a GDP growth of 4.67 percent, inflation in July was 7.26 percent and foreign exchange reserves were $107.6 billion. Meanwhile banking conditions were also much healthier, with NPL at 2.58 percent and CAR of 20.5 percent.

At this point, the domestic private sector really needs to see improving domestic conditions to improve their confidence. Thus, the government should implement sound and consistent policies to beat the downturn cycle. Building confidence by delivering on promises will boost confidence and this is very important at the current time.
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The writer is a financial market analyst at Bank Mandiri.

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