BI prefers non-interest tools to curb high inflation

Bank Indonesia (BI) continues to prefer using a non-interest rate tool to curb surging inflation in the country and to ensure that changes in monetary policy will not affect economic growth, a senior central bank official said.

BI spokesman Difi A. Johansyah said over the weekend that in order to curb rising inflation, the central bank would continue to use its non-interest rate monetary tools, such as adjusting reserve requirements imposed on commercial banks and maintaining the value of rupiah against the US dollar.

“High inflation does not have to be responded to by the BI rate, but it can also be managed through liquidity and currency measures. We don’t want to be drastic, so we will tighten policies gradually,” he told reporters at his office in Jakarta.

Bank Indonesia’s policy to maintain its benchmark interest rate at a record low 6.5 percent since August, 2009 has helped boost economic growth to the government’s target of 6 percent.

The loose monetary policy had however resulted in an overall increase in money in circulation, pushing up the year-on-year inflation rate to a 20-month high of almost 7 percent in December, surpassing the central bank’s 2010 and 2011 target of between 4 and 6 percent.

Foreign market analysts have urged the central bank to tighten its monetary policy by raising rates due to heavy inflationary pressures, but BI Governor Darmin Nasution has said that surging food prices — the main reason behind surging inflation in December — could not be contained by a rate hike.

Difi explained that by increasing the rupiah and US dollar-based minimum reserve requirements, the money in circulation in the nation’s banking system could be reduced in order to stem demand-side inflation.

BI has increased rupiah minimum reserve requirements (GWM) to 8 percent from the previous level of 5 percent starting last November, absorbing Rp 50 trillion (US$5.56 billion) in excess liquidity in the nation’s banks, BI deputy governor Budi Mulya said.

The dollar-based reserve requirement will be increased gradually to 5 percent in March and 8 percent in June this year from the current 1 percent, mopping up an additional $3 billion in liquidity, he added.

“BI is controlling excess liquidity in the market, signaling to the market that we are concerned with the inflationary pressures. We are still waiting on the impact of the increase in the minimum reserve requirements. We will see if a BI rate hike is necessary or other variables could be used [to stem inflation],” Difi said.

Regarding currency tools, BI deputy governor Hartadi A. Sarwono said the central bank had intervened in the foreign exchange market to stem inflation and is targeting Rp 9,000 per dollar as a benchmark to achieve its 2011 inflation target.

“If there is pressure on the rupiah, we enter the market. There we have room to strengthen the rupiah to help stem inflation.

The market reads this, that Bank Indonesia is concerned about inflation by intervening in the market,” Hartadi said, as quoted by Reuters news agency.

As the central bank will push demand-side efforts to stem inflation, Hartadi said he hoped other related-institutions, including the government, could manage the supply-side as inflationary pressures remain due to surging food prices.

Analysts have warned that the central bank would no longer have sufficient room to maintain its benchmark interest rate at the current level with the prevailing inflationary pressure. Many argue that an interest rate hike is needed to keep inflation in check.