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Can the increase in policy rate refine public expectations?
An increase in the BI policy rate risks depressing economic growth, although it has been offset by loose macroprudential policies.
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Cash only: An employee arranges rupiah banknotes at Bank Mandiri in Jakarta on Jun. 23. The currencies of Southeast Asia and the world have been taking on the mighty US dollar this year amid the US Federal Reserves rate hikes. (Antara/Muhammad Adimaja)
B
ank Indonesia (BI) has raised its policy rate, the 7-day reverse repo rate, three times in a row: by 25 basis points (bps) in August, 50 bps in September and October, and now 4.75 percent, the highest since March 2020.
The increase in the policy rate rally was taken as a front loaded, pre-emptive and forward-looking measure to reduce inflation. The annual inflation rate until September, which reached 5.95 percent year-on-year (YoY), is considered to be overshooting the target and needs to be controlled.
The inflation is volatile, triggered by a second-round effect of the increase in subsidized fuel prices in early September. But the increase in the policy rate is projected to anchor general inflation and ensure core inflation returns to the 2-4 percent target in the first half of 2023.
The pressure on the rupiah exchange rate is another reason for the rate hike. The rise in the policy rate is expected to stabilize the rupiah exchange rate at level in-line with its fundamental value, in the midst of a high uncertainty in global financial markets and the strengthening of the US dollar.
The protracted Russian invasion of Ukraine has triggered the world's food and energy crisis and as a major importer of oil and food, such as wheat and soybean, a weakening rupiah will increase imported inflation to Indonesia.
The urgency of a hattrick in raising the policy rate is also in-line with the United States Federal Reserve’s hawkish stance, which may still raise its policy rate further by 75 bps next month. An increase in the policy rate will maintain the interest rate differential between the US and Indonesia; still high enough to prevent capital flight out, but even enough to further woo portfolio capital into Indonesia.
The impact of COVID-19 is fundamental, unprecedented and extraordinary; hitting all economic aspects. The extraordinary impact of the pandemic demands extraordinary policies.
