Pacific Money

Indonesia Battles Inflation, Both Real and Potential

The central bank again raises interest rates, as inflation continues to climb and the currency weaken.

It was not so long ago that Pacific Money commented on Indonesia’s fear of future inflation. Less than a month has passed since Bank Indonesia raised a key interest rate in an attempt to counter a slide in the rupiah, and more importantly to head off inflation associated with fuel-price hikes.

It seems that the measures are now considered to have been inadequate. On Thursday, Bank Indonesia again hiked its deposit facility rate (the amount that the central bank pays lenders on overnight deposits), this time by 50 basis points to 4.75%. The key reference rate was also increased by 50 bps to 6.5%.

The reasoning behind the moves is the same as last time, although admittedly this time the feared inflation resulting from the fuel price increase is no longer hypothetical. Transportation costs jumped 5.48% year on year in June, having only gained 1.64% in May. Overall inflation hit 5.9% year on year in June, up from 5.47% in May.

The rupiah, meanwhile, has continued its slide that began in 2011 and that has been fairly steady throughout 2013. It even continued despite last month’s rate hikes, so it seems that Bank Indonesia is this time using a slightly bigger stick in its efforts to support the currency. The country’s foreign reserves meanwhile dipped below the USD100 billion mark during June. Whilst not a massive fall, this level could have been a “psychological barrier” (i.e., a level at which certain market participant behaviour is triggered), and may thus have contributed to the thinking behind the interest rate decision on Thursday.

Indeed, Indonesia’s trade position is weakening; even China’s domestic situation is affecting Indonesian exports. China’s June imports of coal were down a massive 18% month on month in June, and down 19% for the year. This was due to Chinese domestic coal prices falling below the level at which they become competitive vis-à-vis imported coal – a large portion of which comes from Indonesia.

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The question now is whether or not Jakarta has done enough. With the economy apparently slowing modestly, the Bank Indonesia would obviously rather not raise interest rates again for fear of being behind the curve, creating a pro-cyclical effect. Yet the inflation problem may not go away quickly. The fuel price rise was long overdue, and all that pent up inflation has now been released.