Editorial: Reigning in inflation

Wed, 05/28/2008 12:56 PM | Opinion

Now that the government has increased fuel prices, the burden has shifted to Bank Indonesia to control the resultant price inflation which many expect to run into double digits this year.

'Reigning in' inflation should be the central bank's single objective, as part of its constitutional obligation to maintain the stability of the value of the rupiah on the international market.

The task for the central bank is getting more difficult though, especially after increased fuel prices which are likely to spark a chain of price increases for other products and services.

The fuel price rise will add pressure to the already increasing inflation rate, as the country struggles to cope with higher global prices of food and a loose monetary policy in the U.S.

Higher global food prices have introduced external inflationary pressures, with the cost of domestic cooking oil, soybean and wheat flour nearly doubling since last year.

Luckily, though, the price of rice, the main staple for most Indonesians, remains relatively stable, thanks to the higher-than-expected output last year due to a wetter-than-expected dry season.

Indonesia, like many other countries, has also suffered from the rising fuel prices and this has been reflected in the increasing prices of non-subsidized fuels.

Because of the higher prices of food and non-subsidized fuels, inflation for the first four months of this year had already increased by 4.01 percent -- a figure considered too high, considering the government's initial whole-year target of 6.5 percent.

Now with the recent fuel price increase, inflation is sure to reach double digits, but the question remains just how high will it go?

By government calculations, inflation would not exceed 12 percent, but some economists have warned that inflation could easily exceed that figure.

Judging from past experiences, any increase in fuel prices causes inflation to rise. The last time, in 2005, when the government raised fuel prices by more than 155 percent, inflation shot up to 17 percent.

Now, it is the responsibility of the central bank to take all measures at its disposal to arrest price inflation.

As we know, inflation is attributed to both demand and supply factors. Therefore, the way to influence inflation is also via these two areas.

Increasing fuel prices, a weak rupiah and increasing global commodity prices are all supply factors which would influence inflation.

And these factors are creating inflationary pressure, with the exception of the rupiah which has remained relatively stable so far.

We hope the central bank would play its pivotal role in controlling inflation from the demand side, through restricting the supply of money, which in past years accelerated faster than the real growth of the gross domestic product.

Aggressive BI rate cuts over the last two years caused a rapid expansion of the base money. So, we can assume that aggressive rate cuts were partly responsible for the (high) inflation in 2006 and 2007.

We understand that such expansionary monetary policy in the past two years was necessary, particularly to help drive the dormant real sector.

This year, however, considering the other inflationary pressures, the central bank should put the brakes on such expansionary policy and, if necessary, tighten its control to make sure inflation doesn't run wild.

We welcome the central bank's latest move (earlier this month) to raise its benchmark rate by 25 basis points, to 8.25 percent, anticipating increasing inflation.

We would expect the central bank would again raise the benchmark rate higher, but we also hope its grip on the base money is not punitive to the extent that it would suffocate businesses.

With the disciplined Boediono at the helm, we are confident Bank Indonesia can use its power and resources to keep inflation under control.

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