JEDDAH – While most emerging Asian countries have recovered from the brief hot money outflow led by fears that the Fed may reduce its liquidity injections last summer, Indonesia is still suffering, Kuwait-based Asiya Investments said in a new study. It said the country's economy is very similar to India in the sense that its current account is in deficit, its currency significantly weakened and inflation at very high levels. As a result, Bank Indonesia, the country's central bank, decided to hike its main policy rate once again. Bank Indonesia already hiked rates in each of its monthly meetings since May, except for the month of October, by a total of 150 basis points. It extended the tightening phase in November by raising by another 25 basis points. This came as a surprise to most economists: only one analyst from the 25 surveyed by Bloomberg expected a hike this month. Bank Indonesia's policy rate is currently at 7.5 percent, its highest level in over four years. The Indonesian rupiah has already depreciated by 17 percent since the start of June, becoming the worst performer this year among the 11 major Asian currencies, including Japan. Although it has stabilized over the last month, it still remains subject to high volatility. By raising interest rates, Bank Indonesia hopes to attract inflows into the country, and hence strengthen the nation's currency. Higher inflation has been one of the major consequences of the weakened currency. As the currency significantly weakened, it now takes more rupiahs to import the same good from abroad, which then forces producers and wholesalers to pass through the price increases to the retailers and consumers. Between January and May this year, price increases were range-bound between 4 percent and 5.5 percent year-on-year whereas since July, inflation has been above 8 percent year-on-year. Apart from supporting the rupiah, the rate hikes also aim at curbing demand, through pushing lending rates higher. Credit growth was still rising to 23 percent year-on-year in September, but loans are expected to ease going forward as the cost of borrowing rises and tightening expectations increase. The objective of this is to narrow the current account deficit in part by reducing imports. Inflation is the year-on-year increase in the price of a basket of goods and services. This basket is referred to as the CPI basket and is determined based on the residents' spending habits. The CPI basket contains the costs of food, transport, housing, utilities, and leisure activities. In Indonesia, like other developing nations, food prices make up more than a third of the basket, hence rising food prices have a strong effect on inflation. In order to prevent high inflation, the monetary authorities can decide to hike their policy rates, which directly impacts households spending. By raising rates, the central bank makes borrowing more expensive, and incentivizes households to borrow less, hence spend less. A cut in the policy rate will boost economic activity by encouraging consumption. The Bank Indonesia Rate is the policy rate announced by the Board of Governors of Bank Indonesia in each monthly meeting. The policy rate is used for liquidity management on the money market to achieve the monetary policy operational target. The currency has stabilized in the past few weeks, at above 11,000 rupiah per US dollar – the rupiah was below 9,800 per USD before June. Inflation is also showing signs that it peaked, as it eased from 8.8 percent year-on-year in August to 8.3 percent in October. However, monetary authorities are focused on a different aspect of the Indonesian economy: its current account. Although it improved from its second quarter figure of 4.4 percent of GDP, the country's current account deficit was still wide in the third quarter, at 3.6 percent of GDP. Bank Indonesia expects the current account deficit to narrow further, while government authorities are also aiming at improving the current account. Finance Minister Chatib Basri indicated on Nov. 7 that narrowing the current account deficit was a priority even if it meant lower growth, and that a set of policies to boost foreign investments and reduce imports will be announced before year-end. – SG
