BI's policy on stabilizing the value of the rupiah

BI's policy on stabilizing the value of the rupiah

This is the second of two articles on the rupiah by Achjar
Iljas, the Deputy Governor of Bank Indonesia.

JAKARTA (JP): As the weak and volatile rupiah continues to
pressure inflation, it has limited the ability of a monetary
policy to create a more conducive investment climate. In fact,
the exchange rate pass-through effects to inflation have been one
among other factors significantly contributing to the Indonesian
inflation rate. These pass-through effects of the weakening
rupiah have been largely due to a significant share of imports in
the Indonesian economy.

Furthermore, over time, price adjustments will be even faster
-- less than one month in the recent period -- reflecting partly
producers' markup price setting mechanism. The government's price
and income policies, for instance in April 2001 -- when a number
of policies were issued regarding the retail price of cigarettes,
drinking water, fees and fuels for industries and shipping --
will weigh heavily on inflation.

Given the above situation, with increasingly expected
depreciation and government plans to adjust tariffs on public
utilities such as telephone, expectations of inflation may rise
even higher.

Accordingly, prices for the first five months of 2001 have
been on the upward trend, and the strong inflationary pressure is
expected to continue throughout the year. In May 2001, the
monthly inflation rate was recorded at 1.13 percent. On a
year-to-date (y.t.d.) basis, the cumulative inflation reached
3.73 percent while on an annual basis the consumer price index
(CPI) reached a double digit figure of 10.82 percent -- the
highest rate in the last 22 months.

Among goods and services in the CPI basket, clothing, followed
by food and health products have been the main contributors of
the May inflation.

From a different perspective, the impact of the weakening
rupiah exchange rate is reflected in the traded goods inflation
(4.07 percent y.t.d), which was higher than that of nontraded
goods (3.15 percent y.t.d).

It is quite clear that current monetary developments point to
an increasing inflationary pressure on the economy. As a
conservative central bank, Bank Indonesia (BI) has no choice
other than to direct monetary policy toward containing and
maintaining a relatively low inflation rate as a prerequisite to
sustainable economic development.

This is not an easy task, especially when the short-term
prospect of the economy is also at stake. After factoring in all
relevant indicators and information, it is not surprising that
stabilization of the exchange rate is paramount for controlling
inflation.

In efforts to stabilize the monetary conditions, Bank
Indonesia has taken a number of measures, which include:

* First, as monetary stability is instrumental to stabilizing
the exchange rate, BI's monetary policy has been geared to regain
control of the monetary base expansion.

Therefore, a tight bias monetary policy was implemented since
May 2000. In carrying out its monetary policy, BI mainly uses
open market operations in the form of BI Certificate (SBI)
auctions and rupiah interventions in the money market to squeeze
excess liquidity out of the market.

This tighter strategy will be executed through the achievement
of base money target while constantly optimizing policy mix
instruments.

An ensuing interest rate increase will then be inevitable and
as such monetary control operations will be carried out while the
adverse impact of such increase to economic activities are
minimized. Due to higher expectations on depreciation and
inflation in the first half of 2001, BI tends to apply a front
loaded tight bias monetary policy, as reflected in the increasing
one-month SBI rate around 185 basis points, from 14.53 percent at
the end of December 2000 to 16.38 percent on June 6, 2001.

* Second, BI has also undertaken foreign exchange sterilization
by selling foreign exchange in a timely manner in line with the
adequacy of foreign exchange reserves. This policy is directed at
smoothing out movements in the exchange rate. Under the present
floating exchange rate regime, the central bank will not
necessarily intervene in the market to direct the movement of
exchange rate.

The bank has, however, at discretion, on its free will,
intervened in the market at times when it considered the
movements of the exchange rate could disrupt the orderly working
of the market, and/or could have great impacts on inflation.

* Third, improvement continues in the foreign exchange
monitoring system, which has been developed to better understand
the nature and magnitude of foreign exchange transactions. Such
improvements are aimed to increase the accuracy of information
reported by foreign exchange banks.

* Fourth, Bank Indonesia has also conducted direct monitoring
at a number of banks to enhance compliance with prudential
regulations that relate to foreign exchange transactions, and
monitoring of vostro accounts.

* Fifth, Bank Indonesia has restricted rupiah transactions
between banks in Indonesia and nonresidents as part of the policy
of noninternationalization of the rupiah. This is a prudential
measure aimed at reducing rupiah fluctuations by minimizing the
opportunity for nonresidents to speculate on the rupiah, e.g.
through limiting their access to the rupiah.

These measures will not cure all factors affecting monetary
conditions, especially the stability of the rupiah exchange rate,
but it will certainly help ease somewhat the burden of the
monetary policy in regaining control over inflation.

A final note: The road to sustained recovery may still be long
and bumpy, but the fight against inflation will go on.