Fri, 11 Jun 2004

Central Bank won't raise interest rate

Rendi A. Witular, Jakarta

The central bank will not immediately raise its benchmark interest rate even if the U.S. Federal Reserve finally decides to raise its rate as has been widely anticipated, a Bank Indonesia (BI) senior official said.

BI deputy governor Hartadi A. Sarwono said the central bank would only raise its interest rate if the Fed's move created significant pressure on the rupiah and sparked strong inflation.

"BI won't immediately follow the Fed's move. We will still wait for the effect of the decision on our rupiah and inflation rate," Hartadi told stock market analysts and brokers in a discussion held by the Jakarta Stock Exchange on Thursday.

Bank Indonesia is concerned that an increase in the domestic interest rate would undermine the country's economic growth, he said.

"It is not an easy decision for us to raise the interest rate as anticipated by many, because it will eventually undermine bank lending, which can disturb the development of the corporate sector," Hartadi said.

There has been speculation in the local financial market that the central bank would push the interest rate up amid the prospects of higher inflation due to the current weakening in the rupiah, and the U.S. rate hike plan. But the central bank instead has taken other measures to defend the rupiah.

The Fed, which is scheduled to meet on June 29 and June 30, needs to raise its interest rate from the current 46-year low of 1 percent in order to curb rising inflationary pressure, attract overseas capital to finance its current account deficit, and to strengthen the U.S. dollar.

Hartadi said that market players should not be overly worried by the Fed's plan as the latter was likely to only slightly increase the rate.

"I am optimistic that we can still stabilize our currency and inflation rate, because the hike will be at a maximum of around 25 basis points," said Hartadi.

But foreign media reports said on Thursday that analysts and investors were now expecting the Fed to increase the rate higher than expected due to the stronger inflationary outlook.

This issue brought down most global currencies on Thursday against the U.S. dollar, with the rupiah ending lower at Rp 9,385 from Rp 9,285 on Wednesday.

If the Fed realizes its decision, global investors will choose to pull out their investments in the Asian market and shift to the U.S. market or to U.S. dollar-denominated portfolios, which offer a better net yield and are deemed safer. The shift will eventually strengthen the dollar value but undermine the rupiah.

Hartadi reiterated that BI would go all out to defend the rupiah, in a bid to prevent inflation soaring out of control.

He said that according to BI's calculation, a 10 percent depreciation in the rupiah would lift the inflation rate by 2 percent to 3 percent.

The rupiah has lost an average of 4.8 percent in value against the dollar in May alone due to a combination of internal and external factors such as a possible hike in the U.S. rates, surging oil prices and a possible sharp economic slowdown in China.

"We will try to maintain inflation at around 5 percent to 6 percent (this year). But we predict that if the pressure on the rupiah is heavy, our inflation rate will probably stand at 7 percent at the end of this year, which is still relatively favorable," he said.

A high-inflation environment will increase the burden of the government in servicing its huge domestic debts and undermine people's purchasing power, which has become the main growth engine for the country's economy.