BI keeps rate hike option on table

Dadan Wijaksana and Rendi A. Witular, Jakarta

The central bank says it is keeping open the option to increase its key interest rate in a move to help stabilize the rupiah and curb inflationary pressure.

Bank Indonesia said that it would maintain a "tight bias monetary policy" to ensure a medium-term inflation target of 6 percent to 7 percent.

"Bank Indonesia will try to optimally absorb excess liquidity, without closing the door to an increase in the interest rate," the central bank said in a statement issued after its board of governors meeting late on Tuesday.

Earlier in the day, BI Governor Burhanuddin Abdullah told the capital market community in a ceremony: "We are still open to an increase in interest rates because we can't sacrifice (monetary) stability."

The statement is a sign that BI could change its stance on interest rates. For weeks central bank officials have said that it would avoid an interest rate increase as such a move would slow down economic growth and increase the government's burden in servicing its huge domestic debt. It insisted that the current non-interest rate measures, such as increasing the minimum reserve requirement for bank, were sufficient in absorbing excess liquidity in the banking sector. Excess liquidity could be used to speculate against the rupiah. A weaker currency in turn could trigger inflationary pressure.

BI earlier insisted that a one basis point increase in the interest rate of one-month SBI promissory notes to 7.37 percent last week should not be seen as an indication that the bank would reverse its policy on interest rates. For the past two years, BI has been guiding the SBI rate downward.

But some in the financial market have been speculating that Bank Indonesia would eventually have to increase the benchmark interest rate, particularly amid stronger inflationary pressure, rising U.S. interest rates and soaring oil prices (creating imported inflation). The U.S. Federal Reserve was expected to raise its key interest rate again by 25 basis points to 1.5 percent on Tuesday (Wednesday Jakarta time).

The central bank is scheduled to hold its twice-weekly SBI auction next Wednesday.

The rising trend in the U.S. rate has been seen as one reason why the rupiah weakened by nearly 10 percent recently as some investors switched from rupiah-based assets to dollar assets. The weak rupiah has also been the main factor for the higher inflationary pressure. The Central Statistics Agency reported that annualized inflation in July was 7.2 percent (the highest level in 15 months according to Bloomberg data), which is also higher than the government full-year inflation target of 6.5 percent.

Higher inflation would further undermine the rupiah and consumer purchasing power, especially considering that domestic consumption has been the main engine of economic growth over the past couple of years.

Some bankers have said that an one or two percentage point increase in the SBI rate is unlikely to prompt banks to increase lending rates, currently standing at 16 percent to 17 percent. Higher bank lending rates would make loans more expensive for the corporate sector, which in turn would slow down economic activities.

However, BI said it was optimistic that any change in policy would not harm economic growth too much, saying "economic growth (this year) is expected to reach the upper realm of the 4.5 percent to 5 percent target".