BI strives to control inflationary trends to keep RI buoyant

Wed, 09/10/2008 10:59 AM  |  Business

Global economic uncertainty poses a threat to Indonesia's economic growth, with the risk of inflation, not only from the supply side but from the demand side, forcing policymakers to rethink strategy on how to weather the storm.

The Jakarta Post's Rendi Akhmad Witular recently talked with the central bank deputy governor for monetary affairs Budi Mulya on the current state of the economy. Here are some excerpts from the interview:

Question: What is the most threatening factor to our economy?

Answer: What we are facing right now is pressure on prices, that is, inflation.

While inflation is a global phenomenon, in Indonesia inflation was being triggered initially by supply side problems. There are supply side rigidities as a result of which costs of industrial production are rising due to the impact of soaring prices for global energy and raw materials

Our inflation was more on this type until early last year when there were strong indications that inflation was also being driven by demand side issues. For example, higher economic growth led to the expansion of money supply above normal levels, as well as rapid increases in the sales of cars and motorcycles.

Even though there was an increase in fuel prices (in late May), our economy was shown to be fundamentally strong, evidenced by the continuing increases in sales and in demand for loans. This is very different from conditions back in 2005, when the government increased the fuel prices.

The situation was similar at that time, but the economic fundamentals today are much stronger, supported by rapidly rising demand from areas outside Java, which are benefitting from increased commodity prices.

Demand in Java and Jakarta is robust as well, with growth in the manufacturing sector, despite increasing costs.

Lending has grown rapidly thus far. How sustainable is it?

Lending growth is high. Bank Indonesia (BI) requires all banks to implement their risk management analysis. Banks should exercise this as part of ensuring that they are more prudent. We also want to make sure that bank liquidity is sufficient.

How do you see the economy in the second half?

Overall, growth for this year will be lower than in 2007. We expect growth to reach above 6 percent but below the 6.3 percent recorded in 2007

From the monetary aspect, because we see that inflation is now being driven by the demand side, we will focus on applying a tighter monetary policy. We have already tackled this with several instruments, including interest rate policy, currency intervention and liquidity management.

Other countries may focus their measures on currency, but we are still focusing our attention on interest rate measures. If we don't raise the interest rates, then we are not reinforcing the expectation of economic certainty. Expectations are an abstract idea. If we think inflation will reach 15 percent and we don't act to constrain it, then it will probably happen. So there should be a common expectation between the central bank and stakeholders. There should be a commitment from us.

Can the BI rate move in alignment with demand from the business sector (of not more than 9.5 percent)?

The business community has complained about the current interest rate. But the base rate is just one among the factors determining the success of a company in posting a profit. Soaring energy prices are also a reason for some companies to post a profit.

We should make sure that BI raises the interest rate just to control the inflation. If we do nothing, inflation will accelerate to double digits because of the absence of a pillar of stability. This would in turn create uncertainty for the business community.

How do you see the volatility in the rupiah?

Regional currencies share similar features. This is a global phenomenon because the United States dollar is strengthening against other currencies. This situation (currency depreciation) is not a monopoly of emerging markets, but is also present in Europe and Japan. So this is a global storm. The rupiah is not depreciating lower than other currencies. I would like to emphasize the recent volatility in the rupiah is not triggered by fundamental domestic factors.

Has hot money played any role in the recent rupiah plunge?

Portfolio investors are seeking security and higher yields as reflected by macro stability. There is an inflow of short-term portfolio funds into our economy as can be seen in the rising number of rupiah-denominated assets owned by foreign investors, especially in the Bank Indonesia depository certificates (SBI) and in government bonds.

The amount of foreign funds coming into SBIs has increased significantly. Currently, foreign investors have financed one third of the SBIs.

But for BI, the most important thing is to give them confidence in Indonesia. If the investors feel secure, they will move to higher-yield instruments, such as government bonds, which are more liquid and can be traded in the secondary market.

BI and the government must ensure macro stability to keep the investors comfortable in putting their money here.

How do you see 2009 then? It will be better than 2008. Growth can reach above 6.1 percent while inflation can ease back to between 6.5 percent and 7.5 percent. This is taking into account the impact of the general election.

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