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Cablegate: Macro Risks Persist, Banking Sector Liqudity Tightens

VZCZCXRO9291
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1809/01 2670925
ZNR UUUUU ZZH
R 230925Z SEP 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 0183
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2530
RUEHBJ/AMEMBASSY BEIJING 5431
RUEHBY/AMEMBASSY CANBERRA 3081
RUEHUL/AMEMBASSY SEOUL 4941
RUEHGP/AMEMBASSY SINGAPORE 6331
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 001809

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS, EAP/EP AND EEB/IFD/OMA
TREASURY FOR IA/MALACHY NUGENT AND TRINA RAND
COMMERCE FOR 4430/KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
DEPARTMENT PASS EXIM BANK
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER
DEPT PASS USTR WEISEL, EHLERS

E.O. 12598: N/A
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: MACRO RISKS PERSIST, BANKING SECTOR LIQUDITY TIGHTENS

REF: Jakarta 1755

1. (SBU) Summary. Macroeconomic risks remain significant amid
increased uncertainty and rising risk aversion triggered by U.S.
financial sector developments. Indonesian markets remain volatile,
despite apparently limited direct exposure to troubled U.S.
financial institutions. The Government of Indonesia's (GOI)
financial sector policy coordination has improved markedly since the
Asia financial crisis. The Indonesian banking sector remains
generally sound with strong capital levels and robust credit
quality, but vulnerabilities have increased amid global financial
turmoil. Liquidity has tightened and asset quality is likely to
decline due to continuing negative real interest rates, rapid loan
growth and increased financial sector uncertainty. Reputational
risks for US financial firms operating in Indonesia have also
increased. End summary.

Macro Risks: Capital Outflows, Inflation, Growth
--------------------------------------------- ---

2. (SBU) Indonesia remains vulnerable to increased capital outflows
due to rising global risk aversion in the immediate term, but market
performance in recent days has been more positive. The Jakarta
Composite Index (JCI) ended higher in recent trading, but the index
continues to experience large swings in inter-day trading. The
yield on ten-year Indonesian government bonds fell 66 basis points
on September 22, as investor confidence improved, but the day-to-day
outlook remains uncertain. The IDR also strengthened over the
period September 16 to September 22, ending at IDR/USD 9329 on
September 22, as investors returned to Indonesian markets to take
advantage of lower prices. Bank Indonesia (BI) officials have
denied that the central bank will not allow the IDR/USD exchange
rate to rise above 9500, noting that they intend to intervene
selectively only to smooth market movements.

3. (SBU) Inflation remains a significant concern. Upcoming data
releases (August trade and September inflation figures) will
indicate whether BI's series of rate hikes has succeeded in cooling
down the economy. Thus far, there have been only very preliminary
signs of a slowdown (e.g. slightly slower credit growth (32% yoy) in
August and reduced cement consumption in August). Analysts expect
September consumer price inflation to rise, given higher consumption
associated with the Idul Fitri holiday. IMF Resident Representative
Milan Zavadjil believes that a CPI increase of less than 1% over the
August rate should be viewed a positive development. The IMF
expects inflation to slow through the rest of the year, but a weaker
currency could reverse the current outlook.

4. (SBU) The likelihood of a significant economic slowdown in 2009
continues to increase amid falling global demand and lower commodity
prices. Flagging commodity prices and lower world demand weigh
heavily on Indonesia's export growth, although lower commodity
import prices at least partially offset the impact of global
commodity prices on the trade balance. Analysts expect investment
and domestic demand to slow in 2009, as the real economy absorbs the
impact of tighter monetary policy. The recent decline in oil prices
has reduced the GOI's fuel subsidy bill, but the ability of the GOI
to increase government spending effectively to spur growth remains
limited.

5. (SBU) BI's next major policy decision will come at its October 8
monetary policy meeting. The IMF has urged BI to increase its
policy interest rate again as a signal to markets that BI remains
firmly focused on reigning in inflation and anchoring inflationary
expectations. While the current difficult global conditions and
outlook for slower growth will complicate this decision, market
analysts believe BI is unlikely to hold or cut rates, given ongoing
price and currency pressures.

Better Policy Coordination

JAKARTA 00001809 002 OF 003


--------------------------

6. (SBU) Policy coordination among financial policy officials has
functioned smoothly during the recent global turmoil, according to
BI's Financial System Stability Bureau Head, Dr. Wimboh Santoso.
The Financial System Stability Forum (FSSF), created to insure
against the financial instability that emerged in 1997-98, has been
effective in building stronger interagency relationships and
creating a concrete mechanism for policy coordination. According to
BI, the FSSF is carefully monitoring and sharing all available
financial market data across agencies, enabling the GOI and BI to
make decisions quickly and ensure financial market stability.

Turmoil Squeezes Banking Sector Liquidity
-----------------------------------------

7. (SBU) Global financial turmoil contributed to a liquidity squeeze
among Indonesian banks in recent weeks. Conditions in the interbank
market tightened considerably in September, with the one-month
Jakarta Inter-bank Offered Rate (JIBOR) rising from below 9.5% in
late August to 10.6% as of September 16, prompting BI to reduce the
cap on its repo rate (reftel) on September 16 and inject IDR 4.5
trillion ($483 million) into the interbank market on September 19.
BI is also considering making longer-term repurchase agreements,
which are currently limited to one day, available to the banking
sector. BI's recent moves have been effective in alleviating
liquidity concerns among the banks, according to BI's Wimboh,
although the one-month JIBOR rate has continued to move upward,
closing at 10.8% on September 22. While Indonesian bank direct
exposure to complex financial instruments is small according to BI,
rising risk aversion and general uncertainty about the availability
of credit in global markets may continue to contribute to volatility
in the local interbank market.

8. (SBU) Liquidity conditions in the Indonesian banking sector had
already tightened prior to September due to rapid loan growth (35%
yoy as of July) and weak deposit expansion (11% yoy as of July) in
the banking sector. The JIBOR increased 164 basis points between
April 1 and August 30. Soaring inflation rates in Indonesia have
created negative real rates of interest, which encourage lending and
discourage saving. The loan to deposit ratio of major banks reached
73% in July, up from roughly 65% at the end of 2007. Until very
recently, BI's supervisory policies have also encouraged lending.
In addition to using moral suasion to encourage lending during its
meetings with bankers and the introduction of a government
guaranteed loan program for small and medium-sized enterprises, BI's
reserve requirements have favored banks with higher loan to deposit
ratios. BI officials are discussing a plan to reduce the reserve
policy bias toward increased lending.

9. (SBU) BI officials downplay links between liquidity problems and
the health of the banking system. Capital levels in the Indonesian
banking system remain high and problem loans levels are low.
However, the IMF's adviser to BI's Banking Supervision Directorate,
Raihan Zamil, worries that rapid loan growth may be pushing down
underwriting standards and creating longer-term asset quality
problems. He is concerned that the loans to small- and medium-sized
enterprises, which have expanded rapidly under a
government-guaranteed loan scheme, are creating large fiscal
liabilities for the government. Zamil has also raised concerns
about the analysis used to justify the large expansion of lending to
the commodities sector. It is unclear if banks based these loan
decisions on profitability at peak or normalized commodity prices.
Zamil also noted that BI bank supervisors have now clearly shifted
their mind-set from loan promotion to prudential supervision.
However, a rising number of problem loans booked over the last 18
months may emerge over the next year, further complicating the
economic outlook for 2009.

Reputational Risk Increases for U.S. Financial Firms

JAKARTA 00001809 003 OF 003


--------------------------------------------- -------

10. (SBU) Individual investor losses associated with the Lehman
Brothers bankruptcy and other troubled US financial institutions
threaten the reputation of US financial firms operating in
Indonesia. Although BI officials assert that only a small number of
individual investors in Indonesia are directly exposed to financial
losses from US financial firms, recent press articles have
highlighted individual cases. A front-page Jakarta Post article
cited complaints from Citibank's wealth management clients facing
Lehman Brothers-related losses in their Citibank managed investment
accounts. The complaints center around the lack of warning the
customers received about the risks embedded in their portfolios.
Most affected investors are middle to upper income individuals who
were seeking high yields through complicated investment products.

11. (SBU) Peter Meyer, Chairman of one of AIG's locally incorporated
companies (PT Asuransi AIU Indonesia), told Embassy on September 23
that AIG's Indonesian operations were not in crisis mode and had not
experienced the disruptions AIG's Singapore operations had seen.
While competitors were attempting to gain market share at AIG's
expense, Meyer said his staff is continuing to sell insurance
policies.

HUME

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