BI to raise interest rate to 9.5%

BI to raise interest rate to 9.5%

Phelim Kyne, Dow Jones/Jakarta

The Indonesian central bank's move on Tuesday to raise its benchmark interest rate to 8.75 percent from 8.50 percent foreshadows a series of increases that could drive the rate up to 9.5 percent by the end of the year.

Inflation pressures, a weakening currency and a desire to follow U.S. rate hikes all argue for higher interest rates in Indonesia, analysts say.

"It makes a lot of sense for Bank Indonesia to keep hiking the rate for the rest of the year...I expect 9.5 percent by year- end," said DBS Bank senior economist Chua Hak-Bin.

Bank Indonesia Senior Deputy Governor Miranda Gultom was tightlipped about the future direction of the bank's benchmark rate, but indicated the bank would closely watch the impact on inflationary pressures of the latest increase.

"We will continue to monitor if (the rate hike) contains public inflation expectations," Gultom said.

"We will also continue to monitor the external factors that either directly or indirectly affect inflation such as oil prices and the U.S. Federal Reserve rate."

The U.S. Federal Reserve's policy setting committee on Tuesday hiked the Federal Funds rate by one quarter of a percentage point for the 10th straight meeting. The U.S. central bank's policy rate has risen 250 basis points since June 2004 to 3.50 percent.

DBS Bank's Chua expects Bank Indonesia's future rate rises will track increases by the Fed.

"I think (Bank Indonesia) will pretty much match (rises in) the Fed's rate...just to stabilize the rupiah and address concerns that there's no real weakness there."

Bank Indonesia justified the latest rate hike as necessary to address inflationary pressure driven by rising oil prices and to defend the rupiah from a steady slide against the dollar this year.

Oil prices have hovered around a record high US$60 per barrel in recent months and accelerated inflationary pressure in Indonesia, Southeast Asia's sole member of the Organization of Petroleum Exporting Countries (OPEC).

Indonesia's dwindling domestic output has forced the government to steadily increase the proportion of imported oil in its national energy mix.

But state-owned oil firm Pertamina's voracious appetite for dollars to fund imports has contributed to a 5 percent erosion in the value of the rupiah against the greenback since the beginning of the year, adding to inflationary pressure.

Indonesia's currency market didn't react to Bank Indonesia's latest rate increase, with the rupiah trading at Rp 9,792 against the dollar at 0809 GMT compared with a closing value of Rp 9,795 on Tuesday.

Bank Indonesia's inflation concerns are likely to keep the bank's benchmark rate rising another 50 basis points in the coming months, Merrill Lynch Emerging Asian Forex Strategy head Simon Flint said.

Indonesia's inflation accelerated to 7.84 percent on-year in July from 7.42 percent in June.

"I think we may have to see more (Bank Indonesia benchmark rate) hikes, particularly if inflation continues to rise," Flint said. "In a way, the latest (Bank Indonesia benchmark rate) move simply keeps pace with inflation."

CIMB-GK Research Pte. Ltd Vice President Song Seng Wun said Tuesday's Bank Indonesia benchmark rate increase would lead to a series of others in the coming months that could put the rate at 9.5 percent within nine months.

Higher rates will likely help the government contain inflation and support the rupiah without smothering an officially projected 6.0 percent on-year economic expansion in 2005, he said.

"It's appropriate for (Bank Indonesia) to support the rupiah by hiking rates," Song said. "It won't derail growth but will hit the objective of support of the rupiah in line with inflation control."