“Crowding-out” effect and weakened buying power

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Gede Sandra Economic observer from the People’s Sovereignty Movement (Pergerakan Kedaulatan Rakyat = “PKR”)

IO – Banking credit growth slid downward to minus 0.47% in October 2020, representing the worst credit growth since Indonesia’s 1998 Economic Crisis. The Government, Bank Indonesia, and economists argued that credit growth dropped due to worsening economic condition and the weakening of the people’s buying power. 

Unfortunately, this argument is not entirely true. Another, more dominant factor weakens credit growth and buying power: the crowding-out effect in the Indonesian economy. 

What is this “crowding-out effect”? 

It manifests when the Government continuously and aggressively borrows from the public (i.e., issues Government bonds) at such high interest rates that the business sector ends up reluctant to invest. Low investment gradually drags down the economy, and the people’s buying power weakens. 

How did the crowding-out effect occur in Indonesia? 

To put it simply, most banking funds are sucked in by these interest Government bonds, resulting in banks not having access to sufficient funds for credit. How much banking money is soaked up by Government bonds anyway? 

Financial Services Authority (Otoritas Jasa Keuangan – “OJK”) records per 23 October 2020 stated that the total value of Government bonds in banks is IDR 1,348 trillion. Compare this to last year’s value: Per October 2019, banks only kept a total of IDR 670 trillion in Government bonds. In other words, the amount of banking funds in Government bonds has increased 100% within a year. 

What causes such a large volume of banking funds to be directed to buying Government bonds? Citizens with large deposits in banks prefer to purchase Government bonds because of the high interest rate they offer, and because the State covers all losses in case of financial crisis. This is a far cry from what one can expect from savings or deposit accounts, as the Indonesian Deposit Insurance Corporation (Lembaga Penjamin Simpanan – “LPS”) only covers IDR 2 billion. 

Just how high is Government bond interest rate anyway? 

Publications from the Ministry of Finance state that Retail Savings Bond coupon rates for SBR009 series for the 11 August 2020-10 November 2020 period is 6.3%. Compare that to the average deposit account interest rate (1 year) for 24 national banks at 3.7%, or to the average deposit account interest rates (1 year) of Association State-Owned Banks (Himpunan Bank Milik Negara – “HIMBARA”) banks (BNI, BRI, Mandiri, and BTN) at 3.6%. That means investing in Government bonds will give us a whole 2.6% interest additional profit compared to saving in a deposit account! It is this 2.6% that draws in banking funds to Government bonds, thus starving banking credit growth. And if credit growth is lowered, we can be sure that there will only be a limited amount of monies available among the people, which limits their buying power. 

The key to economic recovery is positive, robust credit growth. China and Vietnam have demonstrated this, by recording positive economic growth during the pandemic. China’s economy grew 4.9%, from being spurred by a skyrocketing credit growth rate at 13%, while Vietnam’s economy went up 2.6% thanks to support from a strong 7.2% credit growth rate. As China is too far away from us in both geographical and economic distance, let’s just compare Indonesia’s situation to that of nearby Vietnam. How can Vietnamese credit growth remain at a strong 7.2%? 

Apparently, the Government bond interest rate, or yield, in Vietnam (10 year) is only 2.3%, smaller than the deposit account interest rate (1 year) in Vietnamese banks at 4%. Government bond interest rate is actually lower than deposit accounts interest rate, unlike in Indonesia! In other words, Vietnam will never lose too much of its banking funds to Government bonds, enabling it to maintain credit distribution for its business sector.