Bank Indonesia’s Dilemma: Reducing or Maintaining the BI Rate at 7.50%?

Why maintain the BI rate at 7.50 percent?

• The next president of Indonesia - Joko “Jokowi” Widodo - might raise prices of subsidized fuels after his inauguration as the country's seventh president in late October. Jokowi stated earlier that the country’s energy subsidies (particularly the fuel subsidies) are too high. He would like to limit government subsidies on fuel consumption, and instead, use the available funds on structural long-term economic and social development. Less imports of expensive oil would also cause a positive impact on the country’s troubled trade balance (and current account balance). However, the decision to raise fuel prices would also trigger sharply accelerated inflation and thus a higher BI rate would be required.

• A higher BI rate helps to ease the current account deficit and support the Indonesian rupiah exchange rate. Indonesia’s current account deficit widened to USD $9.1 billion, or, 4.27 percent of the country's gross domestic product (GDP) in the second quarter of 2014, a widening that was larger than initially forecast. A wide current account deficit results in capital outflows (especially in times of global turmoil or uncertainty) as investors lack confidence in the country's economic fundamentals.

Why the BI rate can be lowered to 7 percent?

• Inflation has eased markedly; after subsidized fuel prices were raised by an average of 33 percent in June 2013, inflation accelerated to nearly 9 percent (year-on-year) in late-2013. However, since the start of 2014, monthly inflation figures have been under control and low. In August year-on-year inflation eased to 3.99 percent, well within the target range of the central bank (3.5 to 5.5 percent for full-year 2014). Inflation at the year-end is estimated at 5.0 percent.

• The European Central Bank (ECB) set its interest rate at a record low (0.05 percent from 0.15 percent) and will increase purchases of asset-backed securities in an attempt to boost lending to small- and medium-sized companies. This monetary easing is conducted in order to avert deflation in the Eurozone and subsequently results in less chances of capital outflows from Indonesia as 'cheap' money will find its way to riskier but more lucrative assets in emerging economies, including Indonesia.

• The US Federal Reserve may postpone to raise US interest rates. Since December 2008, these rates have been 0.0 to 0.25 percent in an attempt to boost economic growth in the world’s largest economy. The Federal Reserve has recently speculated that the ongoing economic recovery of the USA may be in jeopardy if US interest rates are raised too soon. This implies reduced chances of capital outflows from Indonesia.

• Stimulate higher economic growth; between June and November 2013, Bank Indonesia gradually raised the BI rate from 5.75 percent to 7.50 percent in an effort to combat high inflation, curb the wide current account deficit and support the Indonesian rupiah exchange rate (which had depreciated over 25 percent against the US dollar in the second half of 2013). However, a side effect of this monetary tightening was a further slowing of the domestic economy. Indonesia’s GDP growth has been slowing since 2011 due to the global crisis as it impacted on commodity prices (crude palm oil and coal being important export products of Indonesia). Monetary tightening then placed more pressure on GDP growth as it curbs investment growth. After the BI rate was raised to 7.50 percent in November 2013, Indonesian GDP growth fell in the first and second quarters of 2014 (when the impact of the higher BI rate was felt) to 5.22 and 5.12 percent, respectively.

Indonesia's Quarterly GDP Growth 2009–2014 (annual % change):

Year	Quarter I	Quarter II	Quarter III	Quarter IV
2014	5.22	5.12
2013	6.03	5.89	5.62	5.78
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)}

Gross Domestic Product of Indonesia 2006-2013:

	2006	2007	2008	2009	2010	2011	2012	2013
GDP (in billion USD)	285.9	364.6	432.1	510.2	539.4	706.6	846.8	878.0
GDP (annual percent change)	5.5	6.3	6.1	4.6	6.1	6.5	6.2	5.8
GDP per Capita (in USD)	1,643	1,923	2,244	2,345	2,984	3,467	3,546	3,468

^{Sources: World Bank, International Monetary Fund (IMF) and Statistics Indonesia (BPS)}

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