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