According to the Governor of Bank Indonesia Perry Warjiyo, it was necessary to increase the benchmark interest rate in an effort to bring back the inflation within the 2-4 percent target in the third quarter of 2023.
JAKARTA, KOMPAS — The Board of Governors of Bank Indonesia decided to raise the benchmark interest rate by 50 basis points to 4.25 percent during its monthly meeting on Thursday. The aggressive increase in the benchmark rate was made amid a growing internal pressure due to the increase in inflation rate and external pressure caused by the increase in the United States central bank’s reference rate.
Speaking to the press following the Board of Governors' Meeting (RDG), Bank Indonesia Governor Perry Warjiyo explained that the latest rate increase was part of the central bank’s “front-loaded, pre-emptive and forward-looking” policies. Front loaded is a strategy to increase interest rates by a large portion at the beginning of a series of interest rate hikes within a certain period. This is also a pre-emptive step, namely risk mitigation to achieve future targets (forward looking).
According to Perry, until August 2022, core inflation amounted to 3.04 percent on an annual basis. The figure has exceeded the midpoint of BI's core-inflation target range this year, which is 2 percent to 4 percent. The core inflation is expected to continue to increase to 4.6 percent by year-end.
The core inflation and inflation expectations are estimated to rise due to the second-round effect of the adjustment in the prices of the subsidized fuel and a growing domestic demand.
For this reason, Perry said, it was necessary to increase the benchmark interest rate in an effort to bring back the inflation within the 2-4 percent target in the third quarter of 2023.
Exchange rate
In addition, Perry said, the 5-basis-point increase in the benchmark interest rate was aimed at maintaining the stability of the rupiah exchange rate in line with its fundamental value amid global financial-market uncertainty and strong domestic-economic demand.
At the Federal Open Market Committee (FOMC) meeting on Wednesday (21/9) local time, the United States central bank, The Fed, decided to raise its benchmark interest rate by 75 basis points to a range of between 3 percent and 3.25 percent.
The increase in the Fed's interest rate has led to the increase in the US dollar against other currencies, including the rupiah. Citing data from the Jakarta Interbank Spot Dollar Rate (Jisdor), the exchange rate of the rupiah against the US dollar on Thursday (22/9) was recorded at Rp 15,033 per US dollar, decreasing to Rp 15,011 per US dollar on Wednesday.
DBS Bank senior economist Radhika Rao said he earlier expected BI would have raised the benchmark interest rate by 25 basis points. However, considering that on Wednesday the Fed aggressively raised interest rates by 75 basis points, BI also raised its benchmark interest rate higher to 50 basis points.
“I think BI must also look at external factors to maintain exchange-rate stability. The increase is to prevent capital outflows that could trigger a financial shock," said Radhika.
Bank Mandiri economist Faisal Rachman said the 50-basis-point BI rate hike was more aggressive or higher than expected.
He estimates that BI would continue to raise the interest rates until the end of the year, as the increase is still needed as the external pressure will not decrease, while domestic inflation will also continue to grow.
Financial stability
At the 2022 National Working Meeting (Rakernas) on Financial Reporting and Accounting, in Jakarta, on Thursday (22/9), Finance Minister Sri Mulyani Indrawati warned that in the near future the country's financial stability would be tested by two main challenges, namely the spike in world inflation due to disruption of food and energy supplies as well as capital outflows due to the increase in interest rates of the world's major central banks.
“These challenges will affect the assumptions used by the government in preparing the state budget and regional budget. Accountability for state financial management must be well maintained amid an extraordinary situation like this," said Sri Mulyani.
Ministries/institutions as well as local governments are expected to continue to improve the quality of spending or spending priority in order to improve public services while supporting the acceleration of economic recovery. The use of the state money must be measured in accordance with achievements and benefits for national economic stability.
These challenges will affect the assumptions used by the government in preparing the state budget and regional budget.
Sri Mulyani added that the Fed's aggressive steps in raising the benchmark interest rate would affect the global economy. She said the increase would suppress US economic growth, which would have an impact on commodity prices.
“It will affect the projection of the world economy because the US is the largest economy and can affect commodity prices. That's what we have to anticipate," said Sri Mulyani.
Sri Mulyani said that under current conditions, every country, especially developing countries, needs to strengthen resilience to face the risk of foreign capital outflows.
Fortunately, during the COVID-19 pandemic period, Indonesia was able to reduce the ratio of foreign investor ownership in government bonds, which before the pandemic reached 38.5 percent, to 15 percent by the end of August 2022.
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