Bank Indonesia May Hike Interest Rates to Safeguard Financial Stability
Standard Chartered Bank Economist Eric Sugandi expects that the central bank of Indonesia (Bank Indonesia) will have raised its benchmark interest rate (BI rate) by 50 basis points (bps) to 8.00 percent by the end of 2014. Sugandi also said that it is highly unlikely that Bank Indonesia will lower its BI rate in the next two years amid further Federal Reserve tapering and possible US interest rate hikes in 2015 and 2016. Moreover, the Indonesian government may still decide to reduce fuel subsidies further (thus triggering inflationary pressures).
While interest rates are kept low in advanced economies in an attempt to boost economic recovery, several emerging economies - including Indonesia, Brasil and India - are expected to foster a higher interest rate environment as these countries are dealing with current account troubles. However, such policy comes at the expense of higher economic growth. Indonesia's gross domestic product (GDP) is projected to expand by 5.8 percent (year-on-year) in 2014, roughly similar to last year's growth result (5.78 percent). One of the factors that brings economic growth in 2014 is increased household spending amid the legislative and presidential elections. Another important factor is the improved global economy which impacts on Indonesian exports.
Since November 2013, Bank Indonesia has kept the BI rate at 7.50 percent as the country's inflation rate and current account deficit show marked signs of improvement. Meanwhile, the Indonesian rupiah exchange rate - which depreciated over 21 percent against the US dollar in 2013 - has been one of the best performers in 2014 so far.
| Source: Bank IndonesiaPreviously, Deputy Governor of Bank Indonesia Mirza Adityaswara said that the two largest challenges that are currently faced by Indonesia are the curtailing of the country's current account deficit to below the 2.5 percent mark (which is considered sustainable) and the negative impact of tightening US monetary policy.
Fauzi Ichsan, Managing Director and Senior Economist at Standard Chartered Bank, expects that the new Indonesian government (which will be inaugurated in October 2014) will need to curb fuel subsidies in 2015 as these costs place too much burden on the government's budget balance, particularly if the rupiah will start to depreciate again. In June 2013, the government had already increased subsidized fuel prices by an average of 33 percent, triggering high inflation (accelerating to nearly 9 percent year-on-year).