Tuesday, November 18, 2014

Indonesia raises rate 25 bps but welcomes fuel price hike

    Indonesia's central bank raised its benchmark BI rate by 25 basis points to 7.75 percent to ensure that an expected uptick in inflation from the government's 30 percent hike in fuel prices is temporary and that inflation quickly returns to the bank's 2015 target range of 4.0 percent, plus/minus one percentage point.
    Following an extraordinary meeting the day after Indonesian President Joko Widodo announced the sharp reduction in government fuel price subsidies, Bank Indonesia (BI) welcomed the move, saying it would reduce oil imports and thus the current account deficit, while social assistance to the poor will help offset the potential decline in purchasing power and the allocation of funds to infrastructure and productive capacity will ensure sustainable economic growth.
    While the central bank raised the benchmark BI rate 25 basis points in the first rate hike since November 2013, it also widened its interest rate corridor by raising the lending facility rate by 50 points to 8.0 percent and maintaining the deposit rate at 5.75 percent to manage liquidity and support a deepening of financial markets.
    BI, which also raised rates last year in response to a reduction in government fuel subsidies, confirmed its forecast from its regular board meeting last week that economic growth should be in the range of 5.4-5.8 percent next year, adding that it would be higher in the medium-long term.

    Enacting an election promise, President Widodo said late yesterday that he would raise the price of subsidized gasoline to 8,500 rupiah a liter from 6,500 and diesel would be raised to 7,500 from 5,500.decision. The move has spurred speculation that his new government may completely scrap the decades old system of fuel subsidies, with has accounted for more than 10 percent of spending.
    Indonesia's current account deficit has been fueled by a large deficit in oil and gas trade. The current account deficit has left it vulnerable to foreign investors and last year capital started to flow out of the country, putting pressure on its currency, following news that the U.S. Federal Reserve was considering tapering its asset purchases.
   But a total rate hike of 175 basis points by the BI in 2013 help curb inflationary pressures after headline inflation jumped to 8.61 percent in July from 5.9 percent the previous month. Inflation then remained above 8 percent before slowly easing to a low of 3.99 percent in August this year.
    Last month Indonesia's headline inflation rose to 4.83 percent and last week the BI said it expected inflation to continue to trend downwards and meet its 2014 target of 4.5 percent, plus/minus one percentage point.
    In today's statement, the BI implied that it did not expect inflation to meet its target this yea
   Indonesia's current account deficit narrowed to US$ 6.836 billion in the third quarter from $8.689 billion in the second quarter, mainly due to a significant surplus in non-oil and gas balance and positive manufacturing exports and recommenced exports of unrefined mineral exports

    Bank Indonesia issued the following statement:

"The Bank Indonesia Board of Governors, convening on 18th November 2014, decided to strengthen its policy mix in response to the Government’s fuel subsidy reform policy.
First, raising the BI rate 25 bps to 7.75%, with an increase of 50 bps on the Lending Facility rate to 8.00% and the Deposit Facility rate to remain unchanged at 5.75%, effective from 19th November 2014. The increase of BI Rate is to anchor inflation expectation and to ensure that inflationary pressures remain under control and temporary, after the subsidized fuel price hike, and that inflation promptly returns towards its target corridor of 4±1% in 2015. The decision is also consistent with the progress in managing current account deficit towards a more sustainable level. The widening of interest rate corridor for monetary operation is intended to manage the liquidity and support financial market deepening. 
Second, preparing macroprudential policy adjustments in order to enhance funding resources for banks while promoting financial market deepening, and extending loan to productive sectors. Such policy includes 1) extending the definition for deposits by including securities issued by bank in LDR calculation under LDR-linked RR policy, and 2) providing incentives to foster MSME credit allocation.
Third, strengthening payment system policy to support the smooth expansion of government social assistance program to public in order to tight over the impact of fuel price hikes through the use of electronic money and the implementation of Digital Financial Services (DFS).
Fourth, persisting with rupiah exchange rate stabilization policy in accordance with its fundamental value. Subsidized fuel reform policy is perceived to strengthen market confidence and improve the current account position, which is more conducive to future rupiah fluctuations. 
Fifth, strengthening coordination measures with the Government at the central and provincial levels with a focus on efforts to minimise potential inflationary pressures, in particular stemming from rising transportation costs as well as maintaining food prices. Coordination will also be intensified in order to expand fiscal stimuli to productive sectors and further structural reform policy to catalyse economic growth and create employment opportunities. 
Bank Indonesia is assured that strengthening its policy mix and tightening coordination with the Government will maintain macroeconomic and financial system stability as well as support sustainable economic growth.
Bank Indonesia welcomes the Government’s fiscal reform policy in order to reallocate the fuel subsidy budget to productive sectors. Fiscal reform policy represents an essential step and integral part of structural reforms to strengthen economic fundamentals in Indonesia. Despite higher prices in the near term, the policy mix of Bank Indonesia along with tight policy coordination with the Government is expected to control inflationary which is perceived only temporary. The policy is perceived to reduce oil imports and thereby reduce the current account deficit, particularly in terms of the persistently large oil and gas trade deficit. Government policy in terms of social assistance disbursements to the Poor will also offset the potential decline in public purchasing power, which is conducive to private consumption growth. Furthermore, reallocation of the subsidy budget to finance infrastructure development and various productive activities will boost the government’s fiscal capacity in terms of nurturing stronger and more sustainable economic growth. In general, Bank Indonesia projects economic growth in the range of 5.4-5.8% in 2015 and higher in the medium-long term, with maintained macroeconomic and financial system stability."


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