JAKARTA, Aug 23 (Reuters) - A cut in interest rates by Indonesia's central bank may not be enough to give sluggish consumer spending a jolt, as weakness in purchasing power and a reluctance by banks to lend undercuts efforts to boost Southeast Asia's biggest economy.
Bank Indonesia (BI) on Tuesday unexpectedly cut its benchmark policy rate for the first time since October, bringing the rate down 25 basis points to 4.50 percent. It also announced some plans to tweak credit rules in a bid to boost lending and consumption.
Josua Pardede, economist at Bank Permata said expects the average interest rates banks offer to remain above 10 percent by year-end despite Tuesday's policy rate cut.
The central bank had already trimmed the benchmark six times by a total of 1.5 percentage points last year, to limited effect. Commercial banks only followed slowly by lowering their lending and deposit rates, but loan growth has remained weak partly because banks concentrated on tackling bad loans.
Consequently, economic growth in the country with 250 million people has failed to accelerate as policymakers had hoped. The second-quarter's annual growth rate of 5.01 percent - the same as in the first quarter - highlighted how the economy is stuck in a lower gear.
"I think interest rates do not directly affect certain sectors," said Jahja Setiaatmadja, the chief executive of Indonesia's largest bank by market size Bank Central Asia .
"If you lower interest rates for working capital loans but sales have not risen, it wouldn't result in demand for new loans," Setiaatmadja told Reuters.
Policymakers have openly said they are confused over why people aren't spending, with some officials calling it "a mystery". Private consumption accounts for over half of Indonesia's gross domestic product (GDP).
Indonesia's inflation rate is low historically, exports are improving, investment is growing and consumer confidence is high.
Market research firm Nielsen this week said that in the second quarter, consumers in Indonesia were the third most optimistic in 63 countries it surveyed, following only those in the Philippines and India.
MUTED MARKET REACTION
Market reaction to the rate cut was muted, with the rupiah barely moving, while the yield on Indonesia's benchmark 10-year government bonds and the stock index showed only mild gains.
"Subdued market reaction after the rate cut is evidence that market is less optimistic on the direct linkage between lower rates and consumer purchasing intention," said Taye Shim, head of research at Mirae Asset Sekuritas Indonesia.
According to Pardede of Bank Permata, addressing the issue of declining purchasing power in the "middle-low" section - the bottom 40 percent of the population - was crucial. He argued this should be done by using fiscal measures including programmes to create jobs.
"BI wants to boost credit growth and all the changes are directed at the banking industry. But the question is how fast can banks respond by lowering their rates," said Pardede, noting how lenders faced different liquidity conditions and risks.
"As long as purchasing power in the middle-low is still weak, demand for corporate credit will not grow too much," he said.
Another risk to bank lending is bad loans, which in June made up 3 percent of outstanding loans.
The chief banking supervisor at the Financial Services Authority (OJK) Heru Kristiyana said the authority would not extend a 2015 incentive expiring this week that allows flexibility for banks to restructure souring loans.
Banks that still have a high non-performing loan ratio may set aside more provisions, Kristiyana said, which could hit bank profitability, capitalisation and risk appetite. (Additional reporting by Fransiska Nangoy; Editing by Ed Davies and Richard Borsuk)