Raising Interest Rates, BI Steps on the Brakes Early

Bank Indonesia has decided to raise interest rates early as a preemptive measure to cope with inflation in the event of an increase in fuel and food prices.

KOMPAS/ELSA EMIRIA LEBA

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JAKARTA, KOMPAS — Although the core inflation and the rupiah exchange rate have so far been relatively in check, Bank Indonesia( BI) has decided to increase its benchmark rate.

During its board of governors’ meeting on Tuesday, BI raised its benchmark interest rate by 25 basis points to 3.75 percent. The policy is seen as a preemptive measure to cope with future inflation, which may occur in the event of an increase in fuel and food prices.

"The decision to increase the BI 7-Day Reverse Repo Rate (BI7DRR) is a preemptive and forward-looking step to mitigate the risk of rising core inflation and inflation expectations," BI Governor Perry Warjiyo said in a press conference following the BI Board of Governors Meeting (RDG) in Jakarta.

BI has kept its benchmark interest rate at 3.5 percent since February 2021 before raising the reference rate by 25 basis points on Tuesday.

Also read:

> Core Inflation Under Control, BI Holds Rates

> Inflation Threat Haunts Indonesia

Perry said that until July 2022, core inflation was still relatively low, at 2.86 percent on an annual basis (year-on-year/yoy). The rupiah exchange rate was also relatively stable amidst the uncertainty of the global financial market. As of this month, the Indonesian currency has risen by an average 0.94 percent compared to last month due to the return of foreign capital inflow into the domestic financial market.

However, going forward, inflationary pressures are expected to increase, driven by the increase in global food and energy prices, as well as supply disruption. This condition could push inflation in 2022 and 2023 to exceed the upper limit of the target of 3 percent plus-minus 1 percent. Therefore, BI has decided to raise the benchmark interest rate early.

Fuel prices

Speaking on reviewing the progress of the renovation of the Taman Mini Indonesia Indah cultural park in Jakarta on Tuesday, President Joko “Jokowi” Widodo said the policy related to subsidized fuel prices concerned the lives of many people. Therefore, the decision (to increase prices of subsidized fuel prices) should be made carefully. The impact of the price increase should also be carefully calculated.

"The impact must be well calculated so that it will not reduce people's purchasing power or reduce household consumption," said the President.

The subsidy is still maintained by the government. What for? To keep inflation from being too high.

According to the President, the impact of fuel prices on inflation must also be calculated carefully, because it can slow economic growth.

President Jokowi previously said that the annual inflation in July rose by 4.94 percent (yoy), because the prices of subsidies had not been increased. The prices of subsidized fuel such as Pertalite, Pertamax, Diesel as well as liquefied petroleum gas (LPG) and electricity are still far below their economic value.

"The subsidy is still maintained by the government. What for? To keep inflation from being too high. However, will the state budget still be able to cope with it? The Finance Minister will calculate it later," said President Jokowi.

KOMPAS/PRIYOMBODO

Motorcycle queues to fill Pertalite type fuel oil at a gas station in the Larangan area, Tangerang City, Banten, Friday (12/8/2022).

Separately, Coordinating Economic Minister Airlangga Hartarto said at the State Palace in Jakarta on Tuesday that a number of alternative schemes related to the plan to increase prices of subsidized fuel had been prepared and they would soon be reported to the President.

From the various alternative schemes that have been prepared, the President will decide which policy should be taken.

However, Airlangga did not explain when the decision would be taken or announced to the public.

Anticipatory steps

Regarding BI's earlier move to raise the benchmark interest rate, the research director at the Center for Reform on Economics (Core) Indonesia, Piter Abdullah, said it indicated that BI had anticipated the government's plan to increase prices of subsidized fuel.

"It seems that BI already knows that the government will increase fuel prices, so BI anticipated the possibility of a spike in inflation by raising interest rates early," said Piter.

Given the current monetary indicators, BI does not have the urgency to raise the benchmark interest rate. Citing data from the Jakarta Interbank Spot Dollar Rate (Jisdor), the rupiah exchange rate throughout this month has been relatively stable, in the range of Rp 14,700 and Rp 14,900.

In addition, core inflation, which is the reference for BI to see the level of demand and purchasing power of the people, is still under control.

According to data published by Statistic Indonesia (BPS), the core inflation in July 2022 was 0.28 percent. Meanwhile, the annual core inflation in July 2022 reached 2.86 percent and core inflation for the calendar year was 2.86 percent.

The core inflation rate is still within the BI inflation target range, which is 2-4 percent.

Also read:

> Economic Resilience and Fuel Subsidy

> Immediately Decide the Subsidy

The monthly headline inflation in July 2022 reached 0.64 percent while the annual headline inflation in July reached 4.94 percent and the headline inflation in the calendar year reached 3.85 percent.

BI seems to want to share the burden of the government, which no longer has much fiscal space to provide energy subsidies. Now, the allocation of energy subsidies in the state budget has reached Rp 502 trillion.

"I agree with the opinion that BI raised interest rates as an effort to share the burden of the government," said Piter.

However, Piter did not agree if the subsidized fuel price was increased. According to his calculations, if the prices of subsidized fuel were increased, the headline inflation would reach 6-10 percent by the end of the year.

He explained that the increase in prices of subsidized fuel will have a huge impact because it will raise prices due to increased production and transportation costs, not to mention that it could increase inflation from the administered price elements regulated by the government. However, the biggest impact it will have is on the increase in food prices.

Balance

Researchers from the Institute for Economic and Social Research (LPEM) ) of the School of Economics and Business, University of Indonesia (FEB UI), Teuku Riefky, said that the BI rate increase had been expected for a long time. It was just a matter of finding the right time for the central bank to raise the benchmark rate.

Riefky said that BI's decision to raise the benchmark interest rate was intended to establish a balance so that inflation could be controlled and at the same time, the economic growth could be maintained.

"Hopefully, the increase in inflation will not be too high so that the people's buying power could be maintained and the economic growth continues," said Riefky.

This article was translated by Hendarsyah Tarmizi.