B

ank Indonesia (BI) is keeping the benchmark interest rate at its lowest-ever level, but the government’s plan to raise fuel and electricity prices may cause inflation to break the central bank’s target. Following a meeting on Thursday, which decided the BI rate should remain at 5.75 percent, a statement by BI’s board of governors hinted they were more wary of a potential spike in the previously benign consumer price index (CPI).

“Inflation in 2012 could tend to surpass its target because of the temporary impact of the government’s fuel subsidy policy,” the board’s statement read. However, the central bank believed that the inflationary pressures would be “temporary” or a “one-time shock”.

The BI rate is used by banks nationwide as a reference to setting their lending and deposit rates and is used to control the money in circulation to help meet policy makers’ inflation and economic-growth targets.

BI targeted a 3.5- to 5.5-percent CPI increase this year and, as of February, inflation continued to ease, to a 23-month low of 3.65 percent.

Against that backdrop, the central bank has cut the rate three times, by a total of 75 basis points during the past five months, to spur growth over fear that Indonesia would be affected by the slowing global economy.

But the government’s plans to either raise subsidized fuel prices by Rp 1,500 per liter — from the current Rp 4,500 or to cap subsidies by a fixed rate of Rp 2,000 per liter, and to increase base electricity rates by 10 percent, will stoke inflation in the coming months, analysts have said.

“Under these circumstances, we think that BI’s decision is proper to change gear and shift to a possible tightening of the monetary policy in the near future,” Bank Danamon economists Anton Gunawan and Dian Ayu Yustina said in a research note distributed after BI’s policy meeting.

Both they and other economists have started to expect the central bank will hike policy rates by at least 25 basis points later this year to “give a signal to the market and limit the impact of the subsidy-reform program on inflation”.

“In the second half of the year, there’s a possibility that the BI rate will be hiked because inflation will most likely increase significantly as a consequence of a combined increase in fuel and electricity prices,” Bank Negara Indonesia (BNI) chief economist, Ryan Kiryanto, said.

The adjustments in energy prices would also create downside risks for Indonesia’s estimated 6.3- to 6.7-percent economic growth this year, coupled with uncertainties in the global economy, BI’s board of governors said in its policy statement.

“In the future, the board of governors will remain vigilant regarding the impact of the government’s energy policies and the impact of the global economic slowdown on Indonesia’s economy. Bank Indonesia will optimize various policies to minimize the temporary impact on inflation,” the statement maintained.

That included guarding the rupiah against potential sell-offs due to investors’ fear of surging inflationary pressures, the central bank said. The rupiah lost 0.33 percent through February to end the month at Rp 9,020 per US dollar.

Indonesia’s foreign exchange reserves at the central bank, however, increased slightly to US$112.22 billion in February from $111.99 billion in January, BI data showed.