Bank Indonesia's 7.50% Policy Rate in Line with Current Economic Conditions

Most analysts believe that Bank Indonesia's decision to maintain its BI rate at 7.50 percent is a correct one given the present economic context (both domestic and international). A higher BI rate would burden the economy (particularly the real sector) which has already slowed down considerably since the second quarter of 2012. The country's economic expansion is expected to continue its slowing trend in the fourth quarter of 2013 and therefore forecasts for Indonesia's growth in 2013 have been revised down to about 5.7 percent, far below the original target of the government of 6.3-6.8 percent as set in the National Medium Term Development Plan (RPJMN, 2010-2014) as the country needed to adjust to global (and domestic) economic reality. Weak global demand for commodities has seriously reduced the value of Indonesia's export, expensive oil imports burdens the trade balance, while capital outflows occurred in Indonesia's capital markets as investors started to fear the "Fed tapering". These are the factors that - directly or indirectly - caused Indonesia's largest fiscal problems in 2013: high inflation, a wide current account deficit and a sharply depreciating rupiah.

Indonesia's Annual GDP Growth 2009-2014 (annual percentage change)

	2009	2010	2011	2012	2013	2014
Gross Domestic Product (annual percent change)	4.6	6.1	6.5	6.2	5.7¹	6.0¹

^{¹ indicates a forecast}

Indonesia's Quarterly GDP Growth 2009–2013 (annual percentage change)

Year	Quarter I	Quarter II	Quarter III	Quarter IV
2013	6.05	5.83	5.62	-
2012	6.29	6.36	6.16	6.11
2011	6.45	6.52	6.49	6.50
2010	5.99	6.29	5.81	6.81
2009	4.60	4.37	4.31	4.58

^{Source: Statistics Indonesia (BPS)}

Bank Indonesia gradually raised the BI rate between June and November 2013 from 5.75 percent to 7.50 percent in order to curb Indonesia's high inflation, which accelerated to nearly 9 percent (year-on-year) after the government decided to increase prices of subsidized fuels in late June 2013 (in combination with weak government policy regarding import quotas and seasonal celebrations). Although still high at 8.37 percent (November 2013), inflation is now under control and expected to ease to 4.50 percent in 2014. But the higher BI rate also aimed at reducing domestic demand for imports, thus limiting the country's wide current account deficit. In the second quarter of 2013, the current account deficit stood at USD $9.8 billion or 4.4 percent of Indonesia's gross domestic product (GDP), an alarming rate. The deficit then eased to USD $8.4 billion (or 3.8 percent of GDP) in the third quarter. In total, Indonesia's current account deficit in 2013 is expected to reach USD $31 to $32 billion. In combination with the government fiscal policy packages, Bank Indonesia hopes to reduce the deficit further in 2014. A ratio below 3 percent of GDP is regarded as a sustainable level.

2013	Inflation
January	1.03%
February	0.75%
March	0.63%
April	-0.10%
May	-0.03%
June	1.03%
July	3.29%
August	1.12%
September	-0.35%
October	0.09%
November	0.12%
Total	7.79%

	2008	2009	2010	2011	2012	2013
Inflation (annual percent change)	9.8	4.8	5.1	5.4	4.3	7.9¹

^{¹ Year to date (January-November 2013)
Source: Statistics Indonesia}

The current account deficit is also partly to blame for the sharp rupiah depreciation that occurred after Ben Bernanke, in late May 2013, hinted at an end of the Federal Reserve's quantitative easing program. After several futile attempts to stabilize the rupiah through using its foreign exchange reserves, Bank Indonesia realized that the currency's depreciation was ineluctable or - in other words - in line with its fundamentals. Other emerging market currencies also showed significant depreciation against the US dollar. But weak confidence due to the country's wide current account deficit intensified the depreciation in Indonesia's case. It is expected that the rupiah will continue depreciating in the last weeks of 2013 as local companies' US dollar demand (for debt payments) is high.

| Source: Bank Indonesia

As a last remark, it is expected that at the start of 2014 Bank Indonesia will raise its BI rate by 50 bps in order to avert the impact of the winding down of the Federal Reserve's quantitative easing program.

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