Policy Orchestration

The debate about raising interest rates in response to high inflation has taken place almost everywhere and has involved many people, including top economists. Jason Furman of Harvard University represents the group pushing for an increase in interest rates of the United States central bank (The Fed) to fight inflation. Meanwhile, James K Galbraith of the University of Texas, Austin, is on the opposite side, who warns of the risk of rising interest rates on unemployment.

Galbraith has, cynically, quipped that his Harvard colleague would benefit financially from his investments and financial assets if interest rates were raised. The increase in interest rates also involves policy polarization that is oriented towards elite and non-elite groups.

Wherever, an increase in interest rates always poses a dilemma that gets a different response. Although all agree that an increase in interest rates is inevitable, how much and when it will be increased is a matter of debate.

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The rest, monetary policy can never work alone and it is always in an orchestration with other policies that must be played out comprehensively. Relying on interest rate increases alone will be, obviously, not enough. The problem is very complex.

Likewise, when Bank Indonesia’s Board of Governors Meeting (RDG) finally decided to increase the BI 7-Day Reverse Repo Rate (BI7RR) by 25 basis points to 3.75 percent after 18 months without any changes.

There is no urgency to raise interest rates.

Although an increase in interest rates is unavoidable, many people think the policy is too early because so far inflation is still under control. There is no urgency to raise interest rates.

However, inflation is a matter of expectations. Therefore, interest rate policy should refer to the future situation. It is very likely that is why the central bank chose to go ahead of the curve.

High inflation in many countries cannot be separated from the changing landscape of globalization that has occurred recently. If developed countries have so far benefited from the flexibility of resource mobility (capital, labor and natural resources) efficiently, the constellation has changed completely.

In the future, the global economy will no longer be based on efficiency, but on security considerations. As a result, the price level on the world market will tend to increase.

Policy dilemma

In fact, changes have occurred since 2018 when US President Donald Trump launched a trade war against China. Thrown by the COVID-19 pandemic, then followed by changes in the geopolitical constellation marked by the Russian and Ukraine crisis, globalization is no longer the way it used to be.

Global supply chains have changed drastically. Inflation is not only contributed by the abundance of liquidity due to the ultra-loose monetary policy. Inflation is also driven by the sharp increase in global production costs, including food and energy prices.

The domestic economy was affected by the changing global landscape through the increase in the prices of imported commodities. The threat of a food crisis has emerged following the high imports of key foodstuffs, such as wheat. There is panic because prices of some wheat-based products, such as instant noodles, are expected to increase sharply. Likewise, dependence on oil imports will further increase the amount of energy subsidies.

The government takes into account its effect on price increases that can lead to a decline in the level of public welfare.

The plan to reduce prices of subsidized fuel (BBM) has already become a public discussion. Now, the increase in the fuel prices is almost certain and it can result in an increase in the prices of most goods. However, the government looks hesitant to increase fuel prices. The government takes into account its effect on price increases that can lead to a decline in the level of public welfare.

The Finance Ministry has calculated that the current price of diesel at Rp 5,150 (US$0.35) per liter, is far below the economic value or real market price, which has reached Rp. 13,950 per liter. Therefore, the government provides a subsidy of Rp 8,000 per liter. Likewise, the subsidy for the widely used subsidized gasoline Pertalite has reached Rp 6,800 per liter, while the 3 kilogram LPG canister subsidy amounts to Rp 14,250 per kilogram.

As a result, the total fuel subsidy, which was initially allocated at Rp 152.5 trillion ($10 billion) in the state budget, has jumped to Rp 502.4 trillion ($33.8 billion). If there is no price increase, the government’s fuel subsidy by the end of the year could reach Rp 698 trillion ($47 billion). The calculation is based on the price of crude oil of US$105 per barrel, while the exchange rate is Rp 14,700.

The risk of a weakening of the rupiah is quite high, while world oil prices are still uncertain. Not to mention if the level of domestic energy consumption increases than expected.

Apparently, this dynamic will be long term.

The dilemma is quite clear. If the prices of Pertalite, diesel and LPG are not increased, subsidies will swell. However, if the fuel subsidy is removed simultaneously, inflation could rise above 7 percent or hyperinflation will occur. If inflation rises, interest rates need to be raised progressively. Apparently, this dynamic will be long term.

To anticipate this, Bank Indonesia (BI) moved quickly by raising the benchmark interest rate by 25 basis points. Policy orchestration needs to be played by limiting fuel consumption and a moderate increase of around 30 percent. This includes a commitment to increase social assistance spending to protect vulnerable groups who will be affected by price increases. Thus, an orchestration of policies is created, starting from monetary, fiscal, sectoral to social protection schemes.

Public communication related to the discourse on the increase in fuel prices has actually been carried out for quite a long time, even President Joko “Jokowi” Widodo has conveyed it on various occasions and forums. However, the price increase plan is not ready yet because it still requires coordination, including political agreements with parliament and political parties.

Public policy is not always a matter of right or wrong, but it is accepted or not by key stakeholders. In a democratic climate, executing public policies certainly requires a particular expertise.

The urgency of policy consolidation seems to be more important than the communication itself. Various dilemmas in public policy can only be solved by coordination (alignment) to reach consensus. If the discourse has been put forward and policy consolidation has just been carried out, there is a risk that public trust will not be obtained.

KOMPAS/HERU SRI KUMORO

A. Prasetyantoko

A Prasetyantoko, Rector of Atma Jaya Catholic University.

(This article was translated by Hendarsyah Tarmizi)