B

ank Indonesia decided last Friday to maintain its reference interest rate at 6.5 percent but at the same time sent a strong signal that it is committed to managing inflationary pressures by increasing the minimum reserve requirement.

The central bank chose to strengthen growth rather than respond to faster inflation — bucking a trend in other Asian countries such as South Korea, India, Thailand — even though it predicted that annual inflation would exceed 6 percent against earlier estimates of 5 percent, plus or minus 1 percent.

Even though the market is increasingly concerned that the central bank may lose its ability to preempt inflation expectations after the latest inflation figures — which rose to 6.44 percent year-on-year in August, the highest level in 16 months — the central bank correctly decided to uphold the reference rate at 6.5 percent.

After all, general price increases last month had little to do with monetary phenomena but were caused mainly by a 10 percent increase in government-administered electricity rates, a seasonal increase in consumer demand during the Islamic Ramadan fasting month and this week’s Idul Fitri celebrations as well as weather-related disruptions of food commodity supplies.

The worsening global economic outlook, the significant increase in international reserves to almost US$81 billion as of last month as well as the steadily strengthening rupiah seemed to be other factors that strengthened BI’s pro-growth bias, at least temporarily, in its monetary stance.

The rupiah has thus far appreciated 4.2 percent against the dollar this year, the third-best performer in Asia outside Japan, as Indonesia’s expanding economy and its benchmark interest rate, which was higher than those in Malaysia, Thailand and the Philippines, wooed investors. The Jakarta Composite Index has gained 24 percent.

Nevertheless, most analysts foresee a higher interest rate in the last quarter when the evidence on inflation is expected to be more compelling during the run-up to Christmas and New Year celebrations.

Analysts say a timely rate hike would not derail the economy and would instead serve as a signal of Bank Indonesia’s strong commitment to checking inflation.

In a strong signal to the market that it remains alert to the underlying inflationary pressures, Bank Indonesia’s board of governors also decided to raise the primary reserve requirement for commercial banks to 8 percent of third-party deposits in cash from 5 percent in a bid to soak up excess liquidity. But the secondary reserve requirement, which is comprised of a combination of government bonds and Bank Indonesia certificates, was maintained at 2.5 percent.

The statutory reserve requirement and secondary reserve requirement, both measures of how much commercial lenders need to place in deposits at the central bank, are instruments designed to manage liquidity in the banking system.

The central bank also issued another monetary measure to prod banks to step up their financial intermediation (lending) by using the reserve requirement as an incentive/disincentive to urge banks to expand lending.

Bank Indonesia set the loan-to-deposit ratio (LDR) at a range of 78 percent to 100 percent of third-party funds, meaning that banks failing to achieve LDRs within the set range will have their minimum reserve requirement raised further, on top of the maximum 8 percent. But those which can meet the LDR range and still able to maintain their capital standards as set by the central bank will have their minimum reserve requirements cut down.