FOCUS : CHALLENGES FACED BY PROPERTY SECTOR IN 2008

INDONESIAN COMMERCIAL NEWSLETTER

February 2008

FOCUS

CHALLENGES FACED BY PROPERTY SECTOR IN 2008

The construction and property sector is facing heavier challenges in 2008 because of the increases in the prices of building materials notably timber, steel and cement. The price hikes, however, would not reduce the interest of the people in buying houses, apartments and other property buildings, etc. It is obvious from the continued development of new housing, apartment, shopping mall projects boosted by growing demand.

Banks are also more eager to provide credits for the property projects in the form of housing credits (KPA) and apartment credits (KPA) and credits for developers.

Table - 1

Position of property credits by general banks

(Rp. billion)

Year Construction credits Real estate credits KPR and KPA Total property credits

2002 7,500 7,727 21,773 35,000

2003 9,483 7,395 30,108 46,986

2004 15,864 9,324 42,099 67,287

2005 21,433 10,377 56,034 87,844

2006 27,075 15,585 72,713 115,373

Nov 2007 36,417 19,127 93,058 148,602

Source: BI

Banks have determinant role in the development of property business as around 80%-90% buyers of houses and apartments use bank credit facility. With relatively low benchmark (SBI) interest rate of 8%, banks could maintain low interest rates on KPR and KPA, contributing to increase in sales of property buildings especially houses and apartments.

In addition to automotive credits, banks are competing to offer housing credits as the risks are considered low compared with risk of credits for other sectors such as manufacturing sector.

Almost all, major banks have offered to increase the credit portion for housing sector. Bank Mandiri, for example, extended only Rp 4.37 trillion for the housing sector in 2006. In 2007, the banks more than doubled the credit for the sector to Rp 9.30 trillion. Similarly Bank BCA increased its credits for the housing sector from Rp 4.37 trillion in 2006 to an estimated Rp 8.15 trillion in 2007. In the first nine months of 2007 BCA already extended Rp 7.21 trillion in credit for the sector.

State-owned Bank Tabungan Negara (BTN) remains the largest provider of housing credits. Until 2006, BTN had outstanding credits for housing and apartments amounting to Rp 14.58 trillion. In 2007 the amount grew to Rp 16.3 trillion.

Inflation big challenge faced by property sector in 2008

In 2007, low interest rate boosted development of the property sector. Developers, therefore, could carry out their projects despite the rises in the prices of building materials.

However, in 2008 the challenges are heavier as the prices of building materials continue to scale up triggered by the soaring prices of crude oil. The prices of steel, aluminum and timber have continued to rise. Toward the end of 2007, the prices of concrete iron and steel rose by more than 20%.

A number of producers of building materials began to face marketing problem as they were forced to raise their prices with the increase in production cost. Meanwhile the purchasing power of the general consumers has weakened with the rising prices of essential goods.

In January, 2008, month-on-month inflation was 1.77% or the highest for January in four years. In 2005, when year-on-year inflation was 17.11%, inflation in January was only 1.43%. In the following years, inflation in January was 1.36% in 2006 and 1.04% in 2007.

The high inflation in January, 2008 was driven by increase in the prices of food stuff, manufactured foods and houses respectively by 0.74%, 0.34% and 0.49%.

With the prices of crude oil remain high, it is predicted inflation will be higher in 2008 than in 2007 as he government will be in difficulty to maintain the oil fuel (BBM) prices, although the government has pledged not to raise BBM prices. The government already planned to limit the use of subsidized BBM in its bid to use substitute fuels especially for private cars.

Increases have been recorded in the prices of not only BBM but also other essential goods including food products to follow the rises in prices in international market.

The prices of building materials produced with large consumption of fuels such as cement and ceramic also increased. The increase in the prices of building materials results in an increase in the price of houses and other property buildings.

The property market is feared to hit by slump if Bank Indonesia raises its key rate (BI Rate). In order to keep inflation under control it is not unlikely the central bank will raise BI Rate and the impact would be bad for the property sector.

Low interest rate to boost property development

In short term Bank Indonesia (BI) is expected to keep the present interest rate of 8% with the low interest rate of the U.S. Federal Reserve. In January, 2008 the U.S. central bank cut its interest rate by 75 basis points to 3.0% in a bid to create stability in the U.S. share market, which was jolted by the subprime mortgage crisis.

The cut in interest rate by the FED widened the differences in the BI and the FED rates. The big difference could encourage local companies including banks to seek foreign loans. The condition could create bubble economy like it was in before the 1997/1998 crisis when the country was flooded with hot money.

With the FED expected to cut further its interest rate, there will more room for Bank Indonesia to cut its key rate, but it will also depend on the inflation rate as the central bank is more concerned with keeping inflation under control. If inflation in February and March became out of control, Bank Indonesia may be forced to raise its benchmark interest rate.