Louise Williams, Jakarta – In a new effort to arrest the slide of the rupiah, Indonesia's Central Bank has announced that commercial banks may lend hundreds of millions of US dollars from their reserves.

The Central Bank has cut minimum reserve levels for Indonesian banks from 5 per cent of US dollar deposits to 3 per cent, releasing $US850 million ($1.16 billion) into the money market.

But analysts say the reduction in reserves increases the risk for banks if depositors seek to withdraw their savings. The banking sector is already weakened by bad debts and a large number of small and inadequately funded operations.

The credit squeeze was originally imposed by the Indonesian Government in a failed attempt to use high interest rates to prop up the value of the rupiah, which has fallen more than 35 per cent in three months.

But the heavy exposure of many Indonesian companies to US dollar debts has forced the rupiah down, and the Central Bank has been intervening in the market since last week to try to stabilise the currency.

The high interest rates imposed to protect the rupiah have been damaging local business, dramatically slowing construction and threatening industrial production.

The Central Bank also announced it would cut interest rates by about 1 per cent on short-term deposits.

The new strategy comes as talks between the Indonesian Government and the International Monetary Fund near completion on a rescue plan. Unlike Thailand, which exhausted its foreign reserves in a failed attempt to prop up the baht, Indonesia's debt crisis is concentrated in the private sector.

Analysts believe Indonesian companies owe close to $US80 billion, about 60 per cent in short-term debt due in the next three months.