VZCZCXRO6812
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0227/01 0410225
ZNR UUUUU ZZH
R 100225Z FEB 09
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 1429
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS COLL
RUEHKO/AMEMBASSY TOKYO 3008
RUEHBJ/AMEMBASSY BEIJING 5893
RUEHBY/AMEMBASSY CANBERRA 3582
RUEHUL/AMEMBASSY SEOUL 5368
RUEHGP/AMEMBASSY SINGAPORE 6446
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 000227 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS, EAP/EP AND EEB/IFD/OMA 
TREASURY FOR IA/ TRINA RAND AND LOIS QUINN 
DEPT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN 
DEPARTMENT PASS EXIM BANK 
SINGAPORE FOR SBAKER 
DEPT PASS USTR WEISEL, EHLERS 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: PRESSURE ON BANKS WEIGHS ON INVESTMENT, 
GROWTH 
 
¶1. (SBU) Summary.  Emerging pressures on the 
Indonesian banking sector will suppress credit 
growth in 2009.  While the risk of a liquidity 
crisis has abated, deteriorating credit quality and 
high funding costs will squeeze bank earnings and 
erode capital at weaker institutions.  With bank 
lending set to slow and few alternative sources of 
financing, the outlook for investment and growth in 
2009 has diminished.  While the banking sector as a 
whole remains well capitalized, weaknesses among 
smaller institutions could undermine investor 
confidence, increasing the importance of a sound 
regulatory response to emerging problems.  End 
Summary. 
 
Corporate and Consumer Sectors Under Pressure 
--------------------------------------------- 
¶2. (SBU) Credit quality in the Indonesian banking 
sector is set to deteriorate in 2009, limiting the 
banking sector's ability and willingness to increase 
lending.  Signs of weakness in the corporate sector 
have already emerged, with some export 
manufacturers, newer commodity firms and real estate 
developers struggling to make loan payments, 
according to analysts.  Tighter global credit will 
also make it difficult for Indonesian firms to repay 
or rollover the $10-15 billion in foreign currency 
corporate loans that will mature in the next twelve 
months.  Some Indonesian banks are also facing 
defaults on their foreign exchange derivative 
products.  Bank Danamon recently recorded an $80 
million loss associated with customer defaults on 
derivative contracts.  Consumer credit portfolios 
have also deteriorated, particularly outside Java, 
where job losses in the commodity-based sectors have 
increased.  Consumer loan defaults doubled in 
Sumatra in December, rising to 10%, according to 
UBS. 
 
¶3. (SBU) Stress tests indicate that large banks can 
withstand a significant decline in loan quality, but 
some small and medium-size banking institutions may 
suffer capital impairment.  According to UBS's 
Joshua Tanja, Indonesia's five largest banks could 
withstand a 10-12 percentage point increase in non- 
performing loans (NPLs) without reducing their 
capital levels below the 8% regulatory minimum. 
However, a number of small and medium-sized banks 
may need capital injections if non-performing loans 
increase by more than 4-5 percentage points.  While 
the weakest banks do not pose systemic risk on their 
own, collectively they hold roughly 10% of total 
banking deposits in Indonesia, according to Tanja. 
Most bank analysts expect NPLs in the banking system 
to double in 2009, from 3.5% to over 7%.  Bank 
Indonesia (BI) expects NPLs to rise to 5% this year. 
Weaknesses among smaller banks may also prompt 
consolidation in the sector, improving the longer- 
term health of the banking system. 
 
Funding Costs to Remain High 
---------------------------- 
¶4. (SBU) Liquidity conditions have eased for the 
larger banks, but the cost of funds remains high, 
limiting the banks appetite for credit growth in 
¶2009.  Bank analysts note that distrust among 
Indonesia banks persists, restricting the volume of 
interbank lending and access to interbank funds for 
most smaller banks.  Growth in banking sector 
deposits has improved, rising to 15% (yoy) in 
November 2008 from 11% earlier in 2008, but deposit 
growth is concentrated in larger banks and lags 
demand for loans.  Credit growth in November 2008 
exceeded 35% (yoy), indicating that loan demand 
remains high.  Deposit rates across the sector also 
continue to climb.  Banks offered rates as high as 
 
JAKARTA 00000227  002 OF 003 
 
 
16% in January, despite BI's 50 basis point interest 
rate cut earlier in the month. 
 
Less Credit to Take Toll on Economy 
----------------------------------- 
¶5. (SBU) With bank lending set to slow and few 
alternative sources of financing, the outlook for 
economic growth in 2009 has diminished.  BI 
officials have called on the banking sector to 
increase lending by 20% (yoy) in 2009, but bankers 
view this target as unrealistic in light of rising 
credit and funding costs.  Bank analysts expect 
credit growth to fall to 5-10% (yoy) in 2009, as 
bankers tighten underwriting standards and write- 
down problem loans.  While slower loan growth is 
positive from a prudential perspective, the 
forecasted rate cannot fuel significant new 
investment.  The lack of access to global financial 
markets will amplify the impact of slower domestic 
credit growth, as roughly half the financing for 
Indonesian corporations has come from external 
markets in recent years.  Plans to issue new 
government debt could also crowd out private sector 
financing, as banks opt for relatively safe 
government bond purchases over corporate and 
consumer lending. 
 
¶6. (SBU) Analysts continue to downgrade their growth 
forecasts for Indonesia as plummeting exports and 
softening domestic demand parallel the negative 
outlook for credit growth.  Exports fell by over 20% 
(yoy) in December, as both intra- and extra-regional 
trade shrank. Observers expect a sharper dip in the 
coming months.  Signs of a slowdown in domestic 
demand include falling non-oil imports, decelerating 
motorcycle sales, lower core inflation, and rising 
job losses.  The Economist Intelligence Unit (EIU) 
expects the formal unemployment rate to jump from 
8.5% to 9.7% in 2009.  Anecdotal information also 
suggests day laborers, particularly in the 
construction industry, are having difficulty 
securing work.  While the government's planned 
fiscal stimulus should ease some pressure on income 
and jobs, the government has limited capacity to 
mobilize large-scale spending in the near term. 
Both the IMF and the EIU recently reduced their 
growth forecast for 2009, to 3.5% and 1.9%, 
respectively.  Some market analysts are more 
pessimistic, with growth forecasts closer to 1% in 
¶2009. 
 
Bank Weaknesses Pose Risk to Confidence 
--------------------------------------- 
¶7. (SBU) While a system-wide crisis is unlikely 
given the strong capital positions of large 
Indonesian banks, weaknesses among smaller 
institutions could undermine investor confidence, 
increasing the importance of sound regulatory 
responses to emerging problems.  Net capital flows 
have decreased markedly since September 2008 as 
global banks and investors de-leverage and reassess 
emerging risk.  Net portfolio investment in the 
third quarter of 2008 dropped to $17 million from 
$4.2 billion in the previous quarter.  Analysts 
believe that confidence in the health of Indonesia's 
banking and corporate sectors has staved off more 
dramatic capital flight.  As a result, any sign of 
stress in the corporate or banking sectors may 
strain on investor confidence. 
 
¶8. (SBU) The regulatory response to the financial 
crisis to date has been proactive, but pressure on 
the sector in 2009 will test the regulators' 
capacity for crisis management.  Indonesia's 
regulators have pumped liquidity into the banking 
sector and proposed legislation to improve the 
 
JAKARTA 00000227  003 OF 003 
 
 
financial system safety net.  In recent weeks, BI 
has focused on policies to encourage lending by 
delaying implementation of (stricter) Basel II 
capital rules and easing capital requirements for 
loans to small and medium-sized enterprises.  As 
pressure on the banking sector grows, the regulators 
will need to intensify monitoring and evaluation of 
the sector.  Slow resolution of problem banks and 
failure to balance policies that promote loan growth 
with policies that encourage sound banking practices 
are also likely to undermine confidence. 
 
HUME