Annual inflation reached 11.85% in August, a dramatic contrast with the 6.6% rate registered for 2007. In response, BI Governor Boediono told the local press that the bank has decided to raise its benchmark interest rate for September from 9% to 9.25%. After lowering interest rates to 8% in late 2007 and holding them unchanged until May, BI has since raised the benchmark rate four times by a total of one percentage point.
While the inflation figure for the month of September will not be announced until early October, analysts believe that it will further increase as a result of price hikes in basic necessities stemming from increased demand for food and clothing during the Muslim holy month of Ramadan. However, the forecast rise is expected to be only temporary, with the consensus being that food prices have already peaked.
Additionally, most analysts believe that inflation is also set to recede on the back of lower oil prices, which have fallen from a record high of $147 a barrel earlier this year to around $105 a barrel.
Indeed, the year-on-year inflation mark of 11.85% for August was slightly lower than the 11.9% reached in July. BI is now targeting a year-on-year inflation rate of 11.25% for 2008, eventually dropping to 7.5% by the end of 2009.
Haruhiko Kuroda, president of the Asian Development Bank (ADB), told local media during a recent visit to Jakarta, "I am quite sure in the next few months, in emerging economies in Asia, inflation will start to decline, ... including in Indonesia."
Nevertheless, in its most recent outlook report on the region, ADB has identified inflation as a macro-economic challenge that will continue to define most South-east Asian countries this year. The report identifies strict monetary policy as a critical control instrument.
Overall, Indonesia's central bank has been applauded for being quick to react with interest rates adjustments to ensure that they do not fall substantially below inflation growth.
Rakesh Bhatia, chief executive officer of HSBC Indonesia, told OBG, "The government is showing very strong fiscal discipline and has the control measures to be flexible if need be. There will be bumps ahead, but overall the central bank has a lot more depth and capability to handle these bumps than ever before."
BI has been operating an inflation targeting mechanism since July 2005, setting a band each year within which prices may fluctuate, and for which the interest rate acts as the main policy mechanism for maintaining prices.
Additional good news for Indonesia is that while inflation is a concern shared with other countries across the region, the country's forecast growth and trade figures have been less adversely impacted by the US economic slowdown than many of its neighbours.
"Only 10-12% of Indonesia's exports depends on the US market, so we are not affected directly by the crisis there," said Trade Minister Mari Pangestu in a recent media address.
While raising the interest rate is widely agreed to be a necessary measure to keep inflation in check, there is concern about its potential adverse affect on borrowing, in particular for the country's declining manufacturing sector. The sector grew just 3.85% in the third quarter of this year, a decline from the 4.43% growth experienced in the second quarter.
Given that the country's labour-intensive manufacturing industries - such as textiles, footwear, food and beverage and tobacco - are the most affected by the weakening global economy, increased borrowing rates only add to the concern.
Sofjan Wanandi, chairman of the Indonesian Employers Association (APINDO), recently told the local press, "While the global slowdown is hampering demand, the situation at home is also not helpful, with the central bank increasing its key interest rates. ...The rate increase is counterproductive and will cause fewer loans to be channelled to the real sector."