JAKARTA, Reuter - Money is becoming a little cheaper in Indonesia as banks, bled dry by a central bank drain on the rupiah in February, pull funds back into the system.

Powerful state-owned banks, harbingers of government policy, have dropped their prime rates between one and two percentage points to around 26 per cent in the last few days.

"We're seeing an easing (of the crunch on liquidity)," said Bank Indonesia (BI) director Paul Sutopo. "It's desirable not just from BI's point of view -- everybody wants to see interest rates down."

Bankers agree with that emphatically but they don't expect a return to the easy credit of early last year, before BI began its long slow squeeze on the rupiah and then compounded it with shock therapy in February.

"Everyone is surprised at how hard high rates have been hitting people, not just in construction and the obvious sectors but across the board," said one treasury manager. "There's considerable political pressure to push rates down."

At the end of February, Finance Minister Johannes Sumarlin sent money markets, already buffeted by rupiah devaluation rumours, into a frenzy by forcing state-owned companies to buy eight billion rupiah ($4.1 million) worth of SBIs, central bank paper.

SBIs had been used before to suck in funds, but since private banks were reluctant to buy at the uncompetitive rates effectively set by BI, most were sold to state banks. Volumes were small, and SBIs were a blunt instrument, bankers said.

The potential to lock another eight billion rupiah ($4.1 billion) away in central bank coffers changed the illiquid Jakarta market dramatically, although Bank Indonesia has for now dripped most of the money back into the market with repurchase certificates known as SBPUs.

"So we used state companies to create a powerful monetary instrument with SBIs and SBPUs. We now have an ample amount to manage liquidity," Sutopo told Reuters.

"The easing (of tight money) is continuing, but we would like to see it in an orderly manner, with no resurgence of inflation or speculation," he said. "If there are too many rupiah around it will spill over into dollar buying. Then we will use this instrument for contraction."

Inflation, which prompted the central bank to close its fist around the money supply as it approached double figures for the year of 1990 dropped to 0.03 per cent in the month of March from 0.30 per cent in February.

Most bankers see lending rates sliding back to the low 20s by mid-year.

"Of course there will be a lag. Banks were squeezed horribly and they want to make up for it," said one foreign banker.

The downward pressure on deposit rates has begun in earnest. Some state banks on Thursday cut their one-month deposit rates a full three percentage points to 24 per cent, with three and six month money not far behind at 25 per cent.

The more reliable private banks are also wielding the axe on deposits, although with competitors still offering up to 29 per cent, few have dared take their one-month rates below 25.

Consumer credit, which went into overdrive early last year as a swarm of new banks set up and fought for custom, is not likely to return to the dizzy heights of the default-ridden past.

"Private banks went into a consumer lending splurge last year. That's not going to resume any time soon," a banker said.

Another said consumer finance and mortgages, which jumped five percentage points overnight soon after February's "Sumarlin shock", would not drop back in line with other lending rates.

"They (rates) are going to hang around to reflect the real cost of funding, which is a very healthy exercise. A lot of banks took a real beating last year," he said.

A treasury manager warned that the state banks' move to cut rates was something of a chimera.

"It's very much on paper," he said, smarting from being pipped for three-month funds by a state bank that bid 28 per cent.

Bank Indonesia says it is realistic about interest in a market where some banks have paid fantastically high deposit rates to pull in the funds just to keep going after the squeeze.

"We can't hope there will be a sudden drop from all banks. It depends also on their financial structure and whether they already have high commitments," Sutopo said.

The foreign banker said he believed the lowering of rates indicated the market had swallowed and digested the Sumarlin shock.

"But people are forgetting about the underlying squeeze. That won't go away, and it shouldn't."