BI rate hike 'key' to stem inflation

Urip Hudiono, The Jakarta Post, Jakarta

The central bank's latest 1 percent rate hike will without doubt undermine this year's economic growth, a finance ministry senior official said, but was necessary to prevent a prolonged rise in inflation which may hurt the economy even more.

Head of the Ministry of Finance's Economic, Financial, and International Collaboration Studies Agency, Anggito Abimanyu, said on Wednesday the government and Bank Indonesia (BI) concurred that inflationary pressures building up after a recent fuel price hike were currently the main concern, and that a rate hike was then needed to release some of that steam.

"Of course there will be some sacrifices (arising from the policy), among them a slower economic growth, but it is needed to contain a rise in inflation and keep the rupiah attractive," he said.

"If we can absorb that rise in inflation within this year, then we can expect a new equilibrium to be created next year, paving way for a better economic growth."

With the latest rate hike, Anggito admitted that a 6 percent gross domestic product (GDP) growth target in this year's state budget would be too high, and that the government will only be expecting a growth of between 5.7 percent and 6 percent.

"But the (6 percent) target could still be achieved, if we speed up investment realization and government spending by the end of the year," he said.

The central bank raised on Tuesday its benchmark BI Rate by 100 basis points (bps) to 11 percent, in anticipation of inflation that could hit 12 percent following the government's move to more than double the average price of subsidized fuels.

The hike is the fourth since the central bank launched in July the BI Rate as its new inflation-targeting instrument, replacing its three-month SBI promissory notes rate.

The central bank first raised the BI Rate to 8.75 percent to help stem inflation, and then 9.25 percent and 10 percent to help break the rupiah's slump against the U.S. dollar, all within August.

BI governor Burhanuddin Abdullah had said the latest hike was necessary to maintain the more important aspect of macroeconomic stability, even though it might hurt businesses.

State Minister for National Development Planning Sri Mulyani Indrawati had said as well that there would be a trade-off between containing inflation and sustaining economic growth following the fuel price hike, BI's rate hike in response, and the latest Bali bombings, estimating the economy to slow down to 5.7 percent. Indonesia's economy had expanded by 5.86 percent during this year's first half, and 5.13 percent last year.

Like a double-edged sword, raising interest rates help stem inflation, but could also dampen economic growth as it may encourage banks to raise their commercial lending rates, making it pricier for businesses to obtain capital for their expansion needs.

Meanwhile, concerning next year's economic growth prospects, Anggito remained upbeat that the economy could grow between 6 percent and 6.1 percent, citing better economic conditions.