Fitch: Lower Lending Rates in Indonesia May Help Corporates, Squeeze Banks

Indonesia's goal of reducing bank lending rates to single-digit levels will likely benefit most businesses, although banks may have to operate with thinner net interest margins and there are still uncertainties about whether lower lending rates can be sustained, Fitch Ratings says.

Indonesia's financial regulator (OJK), Bank Indonesia and the government have announced that they will form a special team to coordinate efforts to gradually lower the cost of borrowing, which they hope will stimulate economic growth. The goal is to lower the lending rates to single-digit levels by the end of 2016.

Fitch believes that, in general, lower lending rates will reduce the cost of borrowing for businesses, which could increase their competitiveness against global peers. In addition, certain sectors, such as property, auto-makers and consumer goods, will benefit as consumers' purchasing power improves.

Banks and other financial institutions would likely enjoy higher loan growth, although their net interest margins are likely to narrow. Currently, the Indonesian banking sector's net interest margin of 5.4% is the highest in Southeast Asia. Wide margins are a key strength of some of Indonesia's major banks, and any measures that undermine these significantly could be negative from a bank ratings perspective. Fitch expects state-owned banks to lead the initiative to gradually narrow interest margins to support the authorities' goal for lending rates.

The relatively higher lending rates in Indonesia are often cited as a factor that weakens the ability of Indonesian companies to compete globally and an obstacle to economic growth. For example, in 4Q15, the average rates for investment loans, working capital loans and consumption loans were 12.15%, 12.54%, and 13.87%, respectively - all of which are much higher than the lending rates in other countries in the Association of Southeast Asian Nations (ASEAN).

To reduce the lending rates, the authorities have taken several steps. Bank Indonesia has reduced its benchmark rate and the reserve requirement ratio to inject liquidity into the banking system, in an effort to revive economic growth. It is not yet clear to what extent the recent shift in Bank Indonesia's policy stance in favour of growth would come at the expense of stability. The authorities' ability to maintain macroeconomic stability is a key factor for Indonesia's sovereign creditworthiness.

Also more unorthodox measures have been pursued. In 2014, the OJK imposed a ceiling on the interest rates that the bigger banks can offer to time deposit holders after an "interest rate war" raised deposit rates to high levels. The ceiling was lowered further in March 2016. The government has also intervened in the market by allocating IDR10.5trn in this year's budget to subsidise micro loans so that the interest rate for these loans may fall to as low as 9% from 22% to 24% previously. Below-equilibrium interest rates resulting from unorthodox measures could lead to inefficient investment and other unintended consequences. A sustainable single-digit lending rate goal can be achieved if Indonesia is able to maintain relatively low inflation and economic stability while at the same time taking measures to reduce barriers to entry and thereby boosting competition.