Indonesia: An eye on inflation

Text size +-

Inflation in Indonesia picked up in the early months of 2013, as rising prices have constrained the Bank of Indonesia’s (BI’s) ability to loosen monetary policy to encourage GDP growth, with possible further rate rises to come. However, the robust economy is unlikely to suffer much as a result, particularly if other pro-growth measures are taken.

The consumer price index increased 5.9% in March from a year earlier, and core inflation rose 4.21%, driven by factors such as higher food and power prices, according to Indonesia’s Central Statistics Agency. BI has targeted inflation at between 3.5-5.5%, and as core inflation remains within that target, the bank was unable to cut rates at its meeting in early March, despite a slowdown in economic growth and exports.

The bank kept its reference rate on hold at 5.75%, as economists had expected, and will likely maintain this rate at its meeting in mid-April. The board may consider raising rates at future meetings, however, if a fall in the rupiah continues. A falling exchange rate tends to increase inflationary pressure as imports become more expensive.

Meanwhile, the central bank expects GDP growth of 6.2% in the first quarter of 2013 – highly respectable by most international standards, but just outside the target range of 6.3-6.8% for 2013.

The rupiah has been one of the worst-performing of major Asian currencies in 2013, according to Bloomberg, and has been steadily declining against the US dollar since the second half of 2011. The central bank has intensified its policy of currency intervention to shore up the rupiah, and officials have made it clear that rate rises are possible if depreciation continues to feed into inflation. Other factors behind rising prices are food costs due to flooding in January, higher minimum wages and a rise in power tariffs.

Agus Martowardojo, the incoming BI governor, has made it clear that his priority will be containing inflation using monetary tools coordinated with fiscal policy. He will also administer the transfer of responsibility for overseeing commercial banks from BI to the newly formed Financial Services Authority (Otoritas Jasa Keuangan).

Analysts are split on the interest rate outlook, with Prakriti Sofat, a regional economist at Barclays Capital in Singapore, telling international media she expects BI to hold the rate, while Harry Su, the head of research at Bahana Securities in Jakarta, wrote in the local press that “it is safe to assume that the only way for the interest rate to move is up”. Additionally, the IMF stated in September that, “While inflation is within the target band, excess bank liquidity and rapid credit growth warrant continued vigilance and a tightening bias for monetary policy.”

BI already hiked deposit rates to 3.75% in August 2012, and may do so again to encourage capital inflows, which could help bolster the rupiah and bring down the current account deficit. If inflationary pressures ease – and the effects of January’s floods on food prices taper down – it may be able to ward off an increase in the reference rate. If not, a rise cannot be ruled out, though this would likely have little effect on overall economic growth, particularly as the rate is currently at a record low.

A rate hike may send the message, though, that Indonesia is serious about tackling inflation, which has been a challenge for the country in the past, and underlines its emphasis on macroeconomic stability.

Furthermore, interest rates are far from the only way to promote growth. As the IMF has noted, Indonesia has built up fiscal buffers, which allowed mild stimulus measures to be taken in 2012 as headwinds from the global economy increased. Continued investments in infrastructure will not only provide stimulus, but should also help ease bottlenecks that lead to inflation.

Arguably the best way to promote long-term growth, however, is for Indonesia to push ahead with reform to promote investment and trade. The IMF called for reductions in the cost of doing business, labour market liberalisation, investment in human capital and deepening financial markets.

“I’m generally bullish on what Indonesia can achieve over the next 20 years, however, the future hinges on how quickly infrastructure projects can be rolled out,” Tigor M Siahaan, chief country officer of Citibank Indonesia, told OBG. “The country is currently growing at around 6% of GDP but its potential could be closer to at least 7-8% if a trickle-down effect from new infrastructure projects can be felt.

Indonesia ranks 128th in the World Bank and International Finance Corporation’s Doing Business 2013 report, meaning there is much scope for easing regulatory burdens, strengthening and clarifying the legal framework and enhancing the infrastructure available to Indonesian companies and foreign investors. Such measures would indeed promote further growth, as well as relieve some of the inflationary pressure.

Covid-19 Economic Impact Assessments

Stay updated on how some of the world’s most promising markets are being affected by the Covid-19 pandemic, and what actions governments and private businesses are taking to mitigate challenges and ensure their long-term growth story continues.

Register now and also receive a complimentary 2-month licence to the OBG Research Terminal.

Register Here×

Product successfully added to shopping cart

Read Next:

In Asia

Can sustainable architecture help lower the construction sector’s...

Amid efforts to reduce the carbon footprint associated with the construction industry, there is increasing recognition of the benefits of sustainable and regenerative architecture as a means of...

In Economy

Latin America and the Caribbean: Year in Review 2021

Following a difficult 2020, Latin America and the Caribbean has seen a return to growth this year. Although the region still has a long way to go in terms of its vaccine rollout, the pandemic has...


Modest growth expected for South Africa’s stock market in 2014

The Johannesburg Stock Exchange (JSE) enjoyed a good year in 2013, with its growth far outpacing that of the overall South African economy. However, with capital flows to emerging markets...