Inflationary pressures ease

The deflation of 0.02 percent in March could ease concerns about inflationary pressures that were raised by the consumer- price increase of 2 percent in January and 1.52 percent in February, paving the way for an easing in monetary policy.

Though the drop in the consumer price index, as announced by the Central Bureau of Statistics (BPS) on Monday, was very small, it was nonetheless good news which could trigger a chain of positive effects on the entire economy.

Assuming that the monthly movements of consumer prices could be checked at a range from a small decline to a rise maximally of 0.50 percent over the next nine months, and the rupiah exchange rate continues its slight appreciation, the cumulative inflation for the whole fiscal year could be controlled at least at the 9 percent level, as envisaged in the state budget.

Certainly, it is rather impossible to expect deflation for the rest of the year. A certain amount of inflation is needed anyway to provide market signals to increase production and investment.

Moreover, a long period of constant price decreases poses some dangers. If consumers think prices next month will be lower than today, they may postpone buying, thereby depressing production and threatening even lower prices and a deflationary spiral. Steady deflation also hurts borrowers as they will have to repay their debts in costlier rupiah. This is especially true in Indonesia where inflation has so far been caused mainly by higher costs, rather than by the supply-demand equation.

Since inflation is also a matter of expectations, Monday's announcement of deflation would greatly help control excessive inflationary pressures from the rise in domestic fuel prices and the second quarterly 6 percent increase in electricity tariffs that also took place on Monday.

The slight increase of about 3.2 percent in gasoline price as from Monday, compared to the average fuel price rise of 22 percent in mid-January, is the first price adjustment under the government-mandated pricing mechanism launched in January. Under this mechanism domestic fuels, except kerosene, float on the international market using Mid Oil Platts Singapore quotations as the reference prices. The quarterly rise in the power bills has been mandated for the whole year in a gradual step to make electricity prices at least on par with the generation costs of the state electricity company.

Pegging the fuel prices closer to international prices will reduce the incentive for smuggling and will spare the government the political wrangling needed to adjust domestic prices anytime international crude oil prices change.

Low inflation will make the environment much more conducive for the central bank to continue the gradual easing of its monetary policy that was begun early this year.

Last year, the central bank seemed to have been preoccupied with its inflation fight, consequently keeping its benchmark interest rate above 17 percent. That credit crunch turned out to be justified as cumulative inflation last year reached 12.55 percent and the rupiah tended to weaken in the third quarter.

But the central bank has reassessed the supremacy it gave to both its inflation fight and the use of interest rates as its primary policy tool. It has decreased its benchmark interest rate steadily from as high as 17.61 percent in late December to as low as 16.76 percent in late March. Though the rate is still much higher than the average 14 percent assumed for the whole fiscal year, the trend is encouraging anyway.

Achieving the interest rate target is by itself a very positive influence on the fiscal sector because the Rp 60 trillion (US$6 billion) already allocated in the state budget for the government bond interest charges for the fiscal year would not have to be increased, which would be the case if the interest rate remained higher than the assumed level.

Most important, though, is the boosting reverberations of lower interest rates on the economy as a whole. Lower costs of money will pump more liquidity into the economy, thereby enabling businesses to get more working capital to increase production rates.

However, deflation in one month should not be seen as the end of threats of inflationary pressures. Vigilance against inflation should remain high, especially against barriers to distribution of goods. In this context, the government needs to speed up repair works on basic infrastructures in many provinces that have been crumbling due to an acute lack of maintenance over the past four years.