US embassy cable - 05SINGAPORE2906

UNCLAS SINGAPORE 002906 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR TREASURY AJEWELL 
 
E.O. 12958: N/A 
TAGS: ECON, ETRD, EINV, EFIN, PREL, IN, SN 
SUBJECT: SINGAPORE PERSPECTIVES ON INDONESIA'S ECONOMIC 
OUTLOOK 
 
REF: WILLETT-HALL EMAILS 9/30 
 
1. (U) Summary: Singapore-based financial analysts believe 
that Indonesia's economic problems are not a harbinger of 
another Asian financial crisis, and that the risk of 
contagion is small given Indonesia's much stronger 
fundamentals compared to 1997-98.  Although generally 
optimistic about Indonesia's growth prospects through 2006, 
the analysts remained skeptical that Jakarta would correct 
its inappropriately loose monetary policy.  Indonesia, they 
said, would move to reduce fuel subsidies, but needed also to 
move on what they saw as the real problem -- rapid growth of 
the money supply.  End summary. 
 
2.  (U) We met with Singapore-based financial analysts 
Claudio Piron (JP Morgan Chase), Ray Farris (Credit 
Suisse-First Boston), and Euben Paracuelles (DBS Bank) on 
September 22.  Piron expressed confidence that President 
Yudhoyono would be successful in removing Indonesia's 
controversial fuel subsidies over the next several months. 
Financial analysts' estimates on how large the first cut in 
October would be range from 30 percent to 50 percent, but the 
exact number would be less important than the signal Jakarta 
would send by taking action, Piron said.  A subsidy cut in 
this range would send an important sign to investors that 
Jakarta was serious about taking the tough steps necessary to 
get the economy back on track. 
 
3.  (SBU) Ray Farris of Credit Suisse First Boston agreed 
that Jakarta seemed poised to tackle the fuel subsidies 
issue.  He argued, however, that the government's focus on 
the fuel subsidies shifted attention from the real problem, 
one it is not prepared to address -- Bank Indonesia's overly 
loose monetary policy.  The rupiah, he pointed out, did not 
suddenly start depreciating a few weeks ago; it had, in fact, 
steadily lost value since February 2004, long before oil 
prices were an issue.  The monetary base was too large in 
February 2004, Farris explained, and the government 
subsequently allowed it to grow too quickly.  As a result, 
Indonesia's inflation rate was well above the global trend, 
and rising.  While the removal of fuel subsidies will help 
mitigate the government's debt-sustainability problem, it 
will not have a major impact on inflation or the currency, 
Farris concluded. 
 
4.  (SBU) Farris stressed that the solution to Indonesia's 
economic woes was "simple": the government must raise 
interest rates significantly.  The central bank was expected 
to move by about 25 basis points in October if other global 
central banks raise rates, but that would not be enough, 
explained Farris.  He argued that Bank Indonesia (BI) would 
need to ratchet monetary growth down to at most eight 
percent, and preferably five percent, if it were to rein in 
inflation to a reasonable, more sustainable level.  Failure 
to do so would have serious implications for the country's 
investment strategy.  Currently, Indonesia's real interest 
rates are close to zero, and bond yields are not far above 
those in the United States, he said.  Under these 
circumstances, what incentive did investors have to hold 
Indonesian risk, he asked.  Piron agreed, noting that smart 
investors were staying away from Indonesian debt. 
 
5. (SBU) Farris held out little hope that this path would be 
followed, in large part because the Indonesian government did 
not believe that its loose monetary policy was flawed.  "The 
wrong people" are running BI, he observed, and they have 
refused to significantly tighten monetary policy out of fear 
that they would deal a body blow to Indonesia's wobbling 
demand-led growth.  BI failed to understand that its job was 
not to manufacture growth by expanding the money supply, but 
rather to foster a stable monetary environment conducive to 
investment, Farris said.  Paracuelles agreed, citing the lack 
of a political consensus among the leadership for any 
dramatic changes in policy direction.  He noted that Vice 
President Yusuf Kalla was an especially strong supporter of 
continued loose monetary policy.  Kalla had also advocated 
stronger action on fuel subsidies -- arguing that they should 
be completely removed in October instead of gradually reduced 
as the government now intends to do -- possibly as a way of 
alleviating some of the pressure to raise interest rates, 
Paracuelles said. 
 
LAVIN