Bank Indonesia's steps to maintain its benchmark interest rate at 3.5 percent this week shows optimism in the domestic economy, amid the unfavorable global situation.
This unfavorable situation is marked by increasing global risks. Currently, there is a spike in world inflation that has pushed interest rates up in developed countries, the threat of stagflation in the Unites States and the European Union, increasing global supply chain disruption due to the lockdown in China, weakening global growth prospects and the protracted Russia-Ukraine war that exacerbates the world energy and food crisis.
From the monetary side, two interest rate hikes by the US Federal Reserve since March (and there will be more hikes this year) in order to reduce inflation in the US have the potential to trigger a return of capital from developing countries to the US. The capital exodus could threaten the exchange rate and economic stability of developing countries, including Indonesia. One option is to increase interest rates. However, considerations of encouraging economic recovery prevent Indonesia’s central bank from doing.
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There are several factors that enable Indonesia to do this. Its position as a commodity exporter means Indonesia benefits from the surge in global commodity prices, even though Indonesia is also greatly affected by the increase in energy and food prices because it is still dependent on imports.
The economy in the first quarter of 2022 grew 5.01 percent, with nearly all sectors and growth engines experiencing expansion.
In the midst of increasing global risks, domestic economic conditions are also still relatively good, with the economy continuing to show recovery from the effects of the pandemic. The economy in the first quarter of 2022 grew 5.01 percent, with nearly all sectors and growth engines experiencing expansion.
Indonesia's inflation did increase to 3.47 percent, but this figure is relatively moderate compared with many other developing or developed countries. The Russia-Ukraine war triggered a globalized cycle of inflation through soaring energy and food prices, plus China's lockdown that exacerbated global supply chain disruptions. Nearly 80 developed and developing countries recorded inflation above 5 percent.
In the Organization for Economic Co-operation and Development (OECD), the average inflation for 37 countries reached 7.2 percent in January 2022 year-on-year (yoy), with the US at 8.4 percent, Europe 7.5 percent and the United Kingdom 9 percent. In developing countries, inflation in Venezuela in January was 1,198 percent, Sudan 340 percent, Lebanon 201 percent, Syria 139 percent, Suriname 63.3 percent, Zimbabwe 60.7 percent, Argentina 51.2 percent and Turkey 48.9 percent.
ASEAN is relatively under control, at around 3 percent. However, a number of institutions have warned of the upward trend in inflation and the risk of social unrest if the food surge is not controlled.
With developed countries relatively refraining from being too aggressive in raising interest rates for fear of triggering a recession, there is room for Indonesia to temporarily hold off on raising interest rates to spur growth.
The fiscal policy priority should be placed on protecting vulnerable groups that are hit hard by the impact of rising energy and food prices.
However, as Russia’s war in Ukraine drags on, the spike in energy prices will further inflate subsidies and burden the state budget. An unpopular policy of adjusting energy prices may have to be taken, especially with the allocation of subsidies that have not been well targeted so far. The fiscal policy priority should be placed on protecting vulnerable groups that are hit hard by the impact of rising energy and food prices.
(This article was translated by Hyginus Hardoyo)