Benchmark Rate and Growth

Responding to the economic slowdown, Bank Indonesia has yet again taken monetary easing measures, by lowering the benchmark rate.

The lowering of interest rates by 25 basis points (bps) to 6.5 percent - and two other benchmark rates - on Wednesday, is part of BI's efforts to encourage growth amid danger of economic stagnation.

Through lower benchmark rates, it is hoped that lending rates in banks could be pressed, which would hopefully spur investment in businesses and enhance people's purchasing power. BI and the government have targeted that lending rates be below 10 percent (single digit) by the end of 2016, down from the current rate of 12-15 percent. In the first six months of 2016, BI has twice lowered the benchmark rate, but it has yet to have an impact on lending rates.

Other than monetary easing through a lower benchmark rate, BI has also eased a number of macroprudential policies. This move indirectly shows BI's serious concern toward the economic slowdown.

After recording a growth of 4.79 percent in 2015, the GDP in Q1-2016 has only grown by 4.9 percent and the second quarter is predicted to also be under 5 percent.

Is lowering the benchmark rate an effective way to get the economy moving? Monetary instruments cannot stand alone. The lowering of benchmark rates will not automatically be responded to by banks by lowering lending rates. BI's benchmark rate is only one of the things that determine the lending rate.

The lowering of lending rates must be supported through banking efficiency and revamping factors outside of the monetary system. The lowering of lending rates is also not easy given the ratio of loans on savings in banks, which has now reached 92 percent. Amid the increase in bad credit, perhaps credit expansion is not a priority for banks at this moment in time.

The slow growth, which has led to an increase in open unemployment and poverty, has the potential to trigger instability. To cut the cycle of slowed economic growth, creativity and a joint response by the government and BI is needed through the fiscal and monetary stimulus.

Pushing purchasing power and domestic demand is not only done through monetary stimulus but also fiscal stimulus. Different from state spending in 2015, which was able to withstand the economic slowdown stemming from global factors, the fiscal situation is complicated, especially with the uncertain state revenue from the tax amnesty.

Monetary instruments, meanwhile, also cannot operate carelessly. The lowering of the benchmark rate must also take into consideration factors such as the trend of US interest rates, as an effect on the exchange rate and inflation. In addition, the reluctance of the public to invest or spend could also be caused by uncertainty and a decline in trust.

source Kompas, Saturday, June 18, 2016