Thu, 27 May 2004

Boediono optimistic about this year's inflation target

Rendi A. Witular and Dadan Wijaksana, Jakarta

Minister of Finance Boediono said on Wednesday the inflation rate this year would likely be in line with the government's projections, despite fears in the financial market the current decline in the rupiah could fuel inflation.

"Based on our recent study with Bank Indonesia, the inflation rate target this year will remain on track at 6.5 percent. It can even go lower than that," said Boediono during a meeting with House of Representatives Commission IX for finance.

Boediono said his optimism was based on the assumption that the rupiah's fall was only short-lived as the dollar would eventually weaken due to the large current account and trade deficits in the U.S.

"Market players are still worried about the rupiah due to the global psychological effect. But one thing that they missed in their calculations is that the dollar is still vulnerable to depreciation due to the massive deficit in the United States," he said.

He said inflation here could even decline to 6 percent on lower food prices.

The rupiah has been under severe pressure over the past few weeks due to a combination of domestic and overseas factors such as a possible hike in U.S. interest rates, soaring oil prices and political tension ahead of the July 5 presidential election. The rupiah fell to a 19-month low of 9,275 on Wednesday.

The sharp decline in the rupiah has created fears of rising inflationary pressure. A lower rupiah increases the cost of production because of the dependence on imported raw materials. This in turn push prices up.

Worries over inflation emerged earlier this month when the inflation rate in April accelerated to 5.9 percent from 5.1 percent the previous month.

The government was forced to cancel a planned Rp 3.5 trillion bond issue on Tuesday as investors demanded overly high yields due to the rupiah's woes and inflation worries.

Bank Internasional Indonesia's chief economist, Ferry Latuhihin, shared Boediono's optimism, saying inflation this year would mainly be driven by an increase in base money rather than cost-push inflation, as happened during the early period of the late 1990s financial crisis.

"The inflation rate is likely on track despite all the issues, because unlike in the 1997 financial crisis, the recent decline in the rupiah is also driven by an excess of base money," Ferry said.

According to Ferry, base money increased by an average of 14.92 percent in the first quarter of this year from 7.9 percent in the same period last year.

Boediono said that to help stem the rupiah's fall, the government and the central bank should cooperate in order to avoid any miscommunication between the two institutions in taking measures related to monetary and fiscal policies.

"Cooperation is needed between the government and the central bank to prevent any negative signals or confusion in the market due to a lack of coordination between the two institutions," he said.

Elsewhere, Bank Indonesia senior deputy governor Anwar Nasution said that despite the rupiah's decline and the widely expected hike in U.S. interest rates, the central bank had no plans as yet to raise its benchmark interest rate.

"If the Federal Reserve increases interest rates by only 20 to 25 basis points, Bank Indonesia will not increase domestic rates," Anwar Nasution said.

A domestic real interest rate of about 2 percent is still relatively higher than rates in other parts of the region.