Interest Rate Dilemma

KOMPAS/PRIYOMBODO

Foreign currencies adorn the walls outside of a money changer at a shopping center in Kuningan in Jakarta on Tuesday (29/5/2018). The exchange rate of the rupiah against the US dollar weakened to Rp 14,500.

Bank Indonesia (BI) increased its seven-day reverse repo rate (BI 7 DRRR) by a relatively significant 50 basis points (bps), from 4.75 percent to 5.5 percent, on June 29. This was in response to the United States Federal Reserve increasing its reference rate, or Fed Fund Rate (FFR), by 25 basis points from 1.75 percent to 2 percent on June 14. BI’s policy immediately led to the strengthening of the rupiah’s exchange rate, despite it still being lower than the psychological barrier of Rp 14,000 per US dollar. Will the BI 7 DRRR continue to follow FFR’s increase? This is where the interest rate dilemma begins. How should we resolve this?

Long ago, I had predicted that such a dilemma would emerge. Therefore, BI must anticipate any change of FFR that may affect BI’s reference rate, or BI 7 DRRR. This will give way for a dilemma. If FFR is increased three times, it is highly likely that the BI 7 DRRR will not survive. This can significantly increase capital outflow and weaken the Rupiah’s exchange rate. On the other hand, BI wishes to help the government reach its target of a one-digit credit interest rate (Paul Sutaryono, Kompas, 3/3/2018).

Where does the dilemma truly lie? Previously, BI 7 DRRR has increased twice, by 25 bps each, in two consecutive weeks: on May 17 and again on May 30. At the time, the reference rate was 4.75 percent. On the one hand, by increasing its reference rate, BI wants to withhold capital outflow from the local financial market. However, as the BI 7 DRRR is continuously adjusted to the FFR, the increases will inevitably lead to the increase of deposit interest rates. A deposit interest rate war may erupt again.

Let us not forget that deposit interest rate increases will lead to increases of cost of fund for banks, which are required to shell out more funds in the form of higher deposit interest rates for customers. This will lead to credit interest rate increase.

Even when credit interest is relatively low, banking credit has grown by one digit, leading to economic growth of only around 5 percent throughout 2017 and in the first quarter of 2018. The five-percent growth is not bad. However, Indonesia’s economy has a great potential to grow even higher. Therefore, there is a huge concern that the economic growth will be hindered further if credit interest rate increases, even if only a little.

How come? Banking credit growth reflects economic growth in a certain period. BI and the government wishes to implement a one-digit interest rate to boost economic growth. Therefore, BI will launch a stimulus in the form of loan-to-value (LTV) relaxation for the property sector.

Effective tactics

What tactics will be effective to resolve this interest rate dilemma ahead the gloomy global economic conditions?

First, BI 7 DRRR needs to be adjusted following the FFR increase. This aims to maintain the interest rate spread between FFR and BI 7 DRRR. The policy will achieve at least two targets, the first of which is to curb capital outflow. In the first half of this year alone, capital outflow reached Rp 50 trillion (US$3.45 billion).

KOMPAS/PRIYOMBODO

A man walks in a new residential area in Ciledug area, Tangerang City, Banten, on Saturday (30/6/2018). Following a hike in the benchmark interest rate by 50 basis points to 5.25 percent, Bank Indonesia is looking to bolster the performance of the property sector, which has the potential to grow and have a multiplier effect on the national economy.

The second target is to maintain Rupiah’s strength against the US Dollar to curb pressure on current account deficit which has reached US$5.5 billion, or 2.1 percent of the gross domestic product (GDP), as of the first quarter of this year.

Second, the government can push publicly-listed state-owned enterprises (SOE) to buy back their stocks. The move will curb market panic at a time when the Rupiah is deeply depreciated. Consequently, the price of stocks will be normal again and may even go up.

Third, the government can also “pressure” state-owned banks, including Bank Rakyat Indonesia (BRI), Bank Mandiri, Bank Negara Indonesia (BNI) and Bank Tabungan Negara (BTN) to maintain its credit interest rate. Will this work?

Thus far, as agents of development, state-owned banks have always served as pioneers in supporting government programs and as market leaders in the banking industry. Consequently, when state-owned banks maintain its credit interest rates, other banks will follow suit and not increasing their credit interest rates too soon or too high (Paul Sutaryono, Kompas, 5/6/2018).

Fourth, when the deposit interest rate war breaks out once more, the Financial Services Authority (OJK) can impose a deposit interest rate cap. On March 16, 2016, OJK issued a stipulation that banks in BUKU III (with core capital between Rp 5 trillion and Rp 30 trillion) have deposit interest rates of at most 100 bps above the reference rate and that banks in BUKU IV (with core capital above Rp 30 trillion) have deposit interest rates of at most 75 bps above the reference rate.

In short, as the BI 7 DRRR reaches 5.25 percent, deposit interest rates of BUKU III and BUKU IV banks become at most 6.25 percent and 6 percent, respectively. In other words, this is in line with the second strategy: using state-owned banks’ position as market leaders.

The move can be reinforced with the Deposit Insurance Corporation (LPS) delaying its LPS Rate increase. Previously, LPS Rate was increased by 25 bps to 6 percent in public banks and 8.5 percent in rural banks (BPR). Furthermore, LPS Rate for foreign exchange was increased by 50 bps to 1.25 percent in public banks. The interest rate applies between June 6 and September 17, 2018.

At first, LPS Rate was always close to BI Rate. This was understandable as BI Rate is a reference for banks in determining savings interest rate, especially deposits. Afterwards, LPS Rate no longer follows the reference rate but referred to average deposit interest rates. The change was made after BI rate was replaced by BI 7 DRRR on August 19, 2016. The name change also brought a change in reference rate to 5.25 percent. It then decreased to 4.75 percent on October 20, 2016.

Why must LPS delay its LPS Rate increase? It is deeply worrying that, when LPS rate increases, the market will assess that LPS is giving the greenlight for banks to increase their deposit interest rates. Despite the LPS being an independent body, it must support the government’s plan of boosting economic growth. Furthermore, LPS serves to ensure bank clients’ savings and actively maintains banking stability in line with its authority.

surely an LTV relaxation for the property sector will incentivize banks, developers and prospective debtors. The LTV relaxation that will be effective on August 1 this year encompasses several important things.

First is the LTV relief for purchases of first home for all types of homes using housing loans (KPR). LTV ratio for second and subsequent homes will be 80-90 percent, except for type-21 houses that will be freed of LTV. Second is partially prepaid KPR with at most five credit facilities.

Third is the adjustment of loan disbursement of up to 30 percent of loan ceiling after the signing of loan agreement, up to 50 percent of loan ceiling once the house’s foundation is finished, up to 90 percent of loan ceiling once the roofing is finished and 100 percent of loan ceiling after the signing of the sale and purchase deed (AJB).

Fortunately, the purchase of all first houses for all types of home using KPR will be freed of LTV. This means that it will be possible to take a KPR payment scheme without any down payment. Therefore, banks must be more prudent in approving KPR requests. Put simply, banks should apply risk management, especially with regards to credit and compliance risks. Banks should not chase targets while neglecting potential risks.

Banks must continue improving its operation efficiency ratio, or cost-to-income ratio (BOPO). Indonesian Banking Statistics data released on June 22 showed that BOPO decreased from 79.81 in April last year to 79.59 in April this year. The efficiency rate of public banks in general is improving but remains below the 80-percent threshold.

DOKUMEN PRIBADI

Paul Sutaryono

Just look at the net interest margin (NIM) that remains high at 5.07 percent, much higher than average NIM in ASEAN at 3 percent. A high NIM means inefficient banks. To push for higher efficiency, OJK plans to put a NIM ceiling of around 4 percent. However, no further news has been heard about the plan. Banks in all BUKU should restrain themselves when deposit interest rate go up, as NIM will be depleted when credit interest rate remain the same.

It was fortunate that BI’s cash disbursement of Rp 188.2 trillion during the Idul Fitri holiday, as well as the state budget disbursement of Rp 36.2 trillion for the holiday and annual bonuses of civil bureaucrats (ASN), police and military personnel as well as for the government’s capital expenditure, massively boosted the local economy.

Paul Sutaryono, Banking Observer; Former Assistant Vice President, BNI