Inflation surge leaves central bank tough task

Surging inflation in January has given Bank Indonesia (BI) a hard choice of whether or not to raise its benchmark rate during the central bank’s policy meeting Friday (today).

Analysts are divided as to whether the central bank should raise the key BI rate or maintain it at the record low of 6.5 percent, with the first option risking growth and the latter putting the people’s buying power at risk.

The year-to-year inflation rose to 7.02 percent in January as compared to 6.96 percent in December, due mainly to the surge in food prices. In fact, the core inflation slowed to 4.18 percent from 4.28 percent. “Which way will BI go?” Gundy Cahyadi of the OCBC Singapore said.

Although there was a decline in the core inflation, which excludes certain items such as food and energy, most analysts believed that it was high time for the central bank to raise the benchmark rate. They said the inflation threat would continue for the next few months.

The central bank, which has been under pressure to raise its interest rate, has said it would raise the
rate only if the core inflation reached 5 percent.

Due to a higher than expected inflation rate, several analysts have changed their BI rate predictions to “increase” from the previous “hold”. “Inflationary pressures are rising in the economy, and may prompt the BI to kick-off its rate-hike sooner than expected,” Gundy said.

Tony Prasetiantono, former Bank BNI head of research who is now Bank Permata’s independent commissioner, said he previously forecast the BI rate to be held in the central bank’s February policy meeting because he saw January inflation to range between 0.5 and 0.6 percent, lower than the 0.84 percent in January 2010.

“But now that it reached 0.89 percent, I think there will be negative responses if the BI rate is not hiked: sudden reversal, weakening rupiah, falling stock index, lowering foreign exchange reserves,” Tony said in a text message.

Citigroup analyst Johanna Chua also changed her forecast recently, saying “We think consequences for BI not hiking [the rate] this Friday would be far worse in undermining credibility and damaging market sentiment.”

“If BI thinks it will more than likely have to hike eventually, why wait?” she added.

OCBC’s Gundy considered a rate hike imminent, as the current pressure from food prices would make their way to prices across the board sooner or later. “And we have seen evidence that inflationary expectation is already on the rise.”

Therefore, the three analysts foresaw BI hiking rate by 25 basis points to 6.75 percent at its Friday policy meeting to curb soaring prices in the future.

But several other economists, just as BI Governor Darmin Nasution did, questioned whether the surging inflationary pressures — which are mainly caused by surging food prices — could be calmed by raising interest rates.

The rise in the interest rate could affect the country’s ultimate goal to achieve 6.4 percent economic growth this year, because such monetary tightening would increase borrowing costs and it therefore could slow down the economic growth, analysts said.