Through the Looking Glass - injecting liquidity when there's plenty
Introduction
This economist series is the 2nd part, you can read the 1st part here. In this 2nd of the series we will dig deeper and get into the details concerning policies going to be implemented by the Finance Minister known as the "Purbaya Effect".
Why do we need a 2nd part? Mr. Purba has started implementing some policies and I'd like to discuss some of those + there have been some updates which makes things clearer.
IDR 200T additional liquidity to the banking system
State-owned Bank refused initially
--> Why did they refused? Some of the State-owned banks (undisclosed number) were stated to be struggling and even refused the additional liquidity due to the inability to lend new credit with such amount in these economic conditions. High probability its due to the weak economy which leads to high NPL the banks are forced to lend new credits.
The new Finance Minister critized the banks top levels are smart but lazy, so they need to move their asses and make new lending as fast as possible in order to spur growth in the economy. If that's true then yes, the banks need to move and do their part in this weak economy, however I'm not convinced that is the case here...high lending on a weak / struggling economy is always a bad idea for the banking system.
IDR 2,300T undisbursed loans in the banking system
--> Sign of no real demand from the economy. The new Finance Minister argued the IDR 200T is needed to provide additional liquidity the economic system to jumpstart the growth engine. However there's a huge amount of undisbursed loans meaning the economy actually has ample liquidity, it's just there's no demand from businesses to borrow new loans since the economy is slowing and it's bad idea to expand in a slow economy.
There are two major considerations for businesses to borrow new loans:
- State of the economy: clearly it's in a slowing path currently, everyone is halting or reducing purchases caused by weakening purchasing power.
- Cost of loans: recently the Central Bank has decreased interest rate by 25bps to 4.75% which is a great decision IMO since it reduces the cost of loans and that might encourage businesses to start applying for loans.
Given the current weak economic climate, loan costs are the only tool the government can still influence. If the government is serious about its pro‑growth agenda, it must cut interest rates further and make borrowing more attractive for businesses.
The local currency IDR will collapse for sure if the interest rates are reduced aggressively, but that is what must be done in order for credits to start growing again. Also my USD would be happy if IDR weakened!
Banks prefer to put their liquidity in form of gov securities
--> Get 6.5% yield vs 4% cost of fund. Mr. Purbaya also critized the local banks' tendency opting to place their liquidity in safe gov securities rather than channel it to lending. This one I agree, banks' primary mandate is to provide loans which is the lifeline for the economy.
What does this implies?
With all the aspects mentioned above, what does this leads to? In my perspective it would lead to one likely conclusion if the IDR 200T must be absorbed: easing credit conditions. By how much? I don't know, but I surely hope the banks keep their prudency on lending credit.
Other future policies (not yet implemented)
- Will not raise taxes
- No additional budget cuts
- Raise some budgeting area
- Decrease cigarette excise (96% of State's excise revenue) --> annualized 2025 would be > IDR 200T. FY 2024: IDR 216T.
Source of funds?
One question came to mind post reading the points from previous section: where does the source of funds come from? They won't raise taxes, there's no additional budget cuts and even raising some budgets, planning to reduce cigarette excise...how does the gov plan to fund the deficit State Budget?
The answer is clear: either issue more gov bonds or use the Treasury balance. As a matter of fact the State Budget Agency (Badan Anggaran) have just approved a raise of deficit budget to 2.68% from 2.48%, check the news here: Bloomberg, Tempo.
It's not at all surprising, on the contrary it provides a clearer picture of where the gov monetary and fiscal policies are heading.
Conclusion
Pro-growth loose-money policy seems to be gaining traction with Central Bank reduced interest rate and State Budget Agency approved the rising deficit to 2.68%. My hope is that Mr. Purbaya does not forget to apply handbrake if needed and switch back to balanced-mix policy.
The issue with these macro economic events, every pinch of undisciplined or even reckless economic policies will get back to bite the economy in the long run. Imagine a Snowball effect, a small ball of snow rolling down the icy hill..it started small but as it goes down the hill it gets bigger and before you know it, the snowball has accumulated to a giant one, ready to demolish the economy.
Reading between the lines
--> Incentive for SOE Banks to lend to Red-White Credit Union (koperasi Merah-Putih). Check this video source at 33:20 where the gov representative (Mr. Febrio) mentioned about if banks lend to Red-White Credit Union (RWCU) institutions they will get additional 50% discount to their cost of fund --> to only 2% from 4% initially.
From my perspective this is the real incentives that will make the State-owned banks to start lending to the RWCU institutions ~ the delta between cost of fund and their loan interest rate is the potential profit for the banks. So essentially it looks like the gov really want to make sure the RWCU program successful.
The IDR 200T is not really to help the banking system's liquidity, as they already got IDR 2,300T undisbursed loans. It is for RWCU program.
Note the NPL rate in credit union institutions are usually much higher compared to conventional banks:
Single digit 2-3% versus double digits 15-21% NPL numbers it's not even comparable. Why the wide differences between them? It's quite simple actually: those who went to credit unions are people who could not get a loan from bank.
I'm not saying RWCU institutions will have double digits NPL, but I got to provide some data to prove my point on high NPL numbers on credit unions. It's essential for RWCU institutions to apply proper credit due diligence and prudency in order for the NPL number to be single digit as well! If this crucial requirement is neglected then it will bite back sooner or later in form of elevated levels of bad debts.
Note: Unless something significant happens that requires additional updates, this should be the last part of the series.
Comments section here
If you enjoyed this post, click the little up arrow chevron on the bottom left of the page to help it rank in Bear's Discovery feed and if you got any questions or anything, please use the comments section.