BI urged to be cautious over rate

Dadan Wijaksana and Rendi A. Witular, Jakarta

A gradual, limited increase in central bank interest rate remains the best solution to strike a balance between easing pressure on the rupiah and inflation, and keeping banks from raising their lending rates.

A top banker and analyst told The Jakarta Post that the move by the U.S. Federal Reserve on Wednesday to raise its benchmark rate should not be a reason for Bank Indonesia to adopt an aggressive rate policy, as that would harm the economy.

"Even under the current rate, demand for loans from the real sector remains far from ideal and is way below capacity. The prospect would be gloomier if the rate were raised," President of Bank Negara Indonesia (BNI) Sigit Pramono said.

"A rate hike will still be tolerable as long as it is below 1 percent as we can still cope with that without having to raise lending rates," Sigit added.

He was referring to the central bank's Tuesday announcement that it was keeping the option of a rate hike open amid mounting inflationary pressure. The Fed's move to lift its key rate to 1.5 percent from 1.25 percent could add to the reasons for the bank to raise its rate.

However, Citigroup economist Anton Gunawan was of the opinion that it was not yet necessary for Bank Indonesia to aggressively raise its rate.

"While Citigroup is maintaining its projection that the U.S. rate will reach 2 percent by year-end, we do not see BI as rapidly following suit.

"Even if it had to increase the interest rate, the rise would be slow and by a small margin," Anton said.

In its latest auction last week, Bank Indonesia raised by one basis point its one-month interest rate to 7.37 percent from 7.36 percent. On Tuesday, it said that in order to help maintain inflation at between 6 percent to 7 percent, the central bank would not rule out further rate hikes in near future.

In July, based on the latest report by the Central Statistics Agency (BPS), year-on-year inflation reached the worrying level of 7.2 percent, higher than the government's average rate target of 6.5 percent.

Anton predicted, however, that while the rupiah's volatility -- partly blamed on the high level of inflation -- was likely to remain at least until after the new government was formed, the local currency would start to rebound ahead of year-end and inflationary pressure would abate, he said.

"With controlled, full-year inflation, maybe at around 7 percent, the SBI will rise only to around 7.75 percent at the end of the year," Anton said, adding that such a modest raise would not force banks to increase their lending rate.

Chief economist of Deutsche Bank Group Norbert Walter said the hike in the Fed's interest rates would likely push more local firms to seek cheaper capital from the stock market, as bank lending would eventually become more expensive.

"Financing for investment will be expensive as interest rate increases. We expect there will be more companies selling their shares in the stock market to obtain capital for their operations ... . This is good for the country," he said.