The fuel price hikes in May resulted in double-digit inflation. By July 2008, the year-on-year inflation rate had reached 11.97 percent.
Some analysts might have contended that the heightening inflationary pressures were likely to hurt consumer purchasing power and thereby lead to slower economic growth. Danareksa's consumer survey suggests, however, consumer spending is likely to continue fueling economic growth.
In June, following the fuel price increases in May, Danareksa's Consumer Confidence Index (CCI) fell to 65.3. This was the lowest the CCI has ever been in the history of the survey. The fall suggested that the fuel price increases had increased the burden shouldered by consumers, denting their confidence in the economy.
The concern is unless the CCI rebounds in coming months, consumers may begin to cut back on spending. Any cutbacks in consumer spending would have major impacts on the economy since household spending accounts for 65 percent of the Gross Domestic Product (GDP).
Fortunately, however, consumer purchasing power is not likely to be eroded further, given that the impact of the fuel price increases was fully reflected in the inflation figure by July.
According to Danareksa's calculations, every 10 percent increase in average subsidized fuel price would increase inflation by around 0.7 percent. This means the fuel price increases of 28.7 percent (average) in May would increase inflation by around 2 percent.
Without the fuel price increases, we predicted inflation in July would reach slightly more than 9 percent. Thus, the July inflation data suggests the fuel price increases had a bigger impact on inflation than we predicted.
Furthermore, past experience suggests that the ramifications of fuel price increases on inflation last for only three months after the prices are raised, with the biggest impacts occurring in the first two months.
We can therefore conclude that inflation should be on a downward trend in coming months.
The latest data on consumer confidence is encouraging. After a four-month decline, the CCI climbed 11.3 percent to 72.7 in July.
Both components of the CCI rose. The Present Situations Index (PSI) surged 17.7 percent to 54.5 in July from its lowest ever level of 46.3 in June, while the Expectations Index (EI) rose by 8.5 percent to 86.4 from its lowest ever level of 79.6 in June.
The rebound in the EI suggests consumers do not expect economic conditions to get worse in the next six months, meaning they would be unlikely to cut back on spending in the near term.
The 17.7 percent rise in the Present Situations Index was driven by a 20.7 percent surge in the index measuring sentiment toward current national economic conditions, and a 20.3 percent increase in the index measuring sentiment toward the state of the job market.
Consumers also held less negative views in regard to current local economic conditions. Numbers claiming conditions were "bad" fell from 42.4 percent to 35.1 percent, while those who claimed conditions were "good" edged up from 11.7 percent to 14.7 percent.
Overall, the index measuring sentiment toward current local economic conditions rose 14.9 percent to 79.6 in July.
Consumers also foresee better prospects for the national economy in the near term. Indeed, the proportion of consumers expecting stronger national economic conditions rose to 12.6 percent in July from 9.2 percent in June.
Similarly, the proportion of consumers expecting weaker national economic conditions dropped to 32.0 percent in July from 34.1 percent in June.
On the prospects for the local economy, confidence also rose. After falling to its lowest level ever in June, 82.8, it rebounded 8.8 percent to 90.1 in July. And given hopes of a stronger national economy, consumers were less downbeat on the job market (the relevant index gained 5.6 percent to 87.2).
Danareksa's survey shows the proportion of consumers anticipating a tougher job market declined to 21.9 percent in July, from 24.0 percent in June, while the proportion of consumers expecting jobs to be "plentiful" rose to 9.0 percent in July, from 6.6 percent in June.
Of the four components of the EI, the biggest increase was seen in the area measuring sentiment toward family income prospects. This component surged by 12.3 percent to 87.7 in July from its lowest ever level of 78.1 in June.
The improvement in this component stems from hopes that the economy shall pick up and that new jobs shall be created. With more people in work, family incomes will see gains.
High inflation, however, has prompted the central bank to increase interest rates further.
It increased the benchmark BI rate on Tuesday by 25 basis points to 9 percent, creating concerns for the sustainability of the economic expansion and hurt consumer confidence going forward, especially if the central bank decides to increase interest rates further.
We, however, do not believe the central bank needs to increase interest rates too much given the outlook for benign inflation going forward. Hence, we do not expect the central bank to increase its rate significantly higher than 9 percent in coming months.
The prospect of only limited increases in the BI rate bodes well for the economy. Past data suggests as long as the BI rate remains below 9.5 percent, the economy can still expand briskly.
In summary, despite the heavier burden shouldered by consumers due to ever rising food prices, consumer confidence is not likely to fall further in the coming months. Consumer confidence also rebounded in July, and is unlikely to rise further going forward.
The prospect of interest rates remaining low may support consumer confidence, meaning households should continue spending.
Against this backdrop, we believe the prospects for the economy remain bright. For the full year of 2008 we expect the Indonesian economy to grow by around 6.28 percent.
The writer is the chief economist at Danareksa Research Institute
Find Article by Date