Indonesia central bank governor flags earliest rate hike in Q3

Indonesia’s central bank may raise interest rates in the current quarter to contain future pressure on core inflation, but any hike will not be aggressive and the size will hinge on the scale of energy subsidies next year, its governor said.

Bank Indonesia (BI) is one of a few major Asian central banks not to have lifted rates from pandemic record lows due to a relatively low inflation rate and a nascent economic recovery from the COVID-19 pandemic.

“The earliest will be in the third quarter of this year,” Governor Perry Warjiyo said in an interview, when asked about the likely timing of BI’s first rate hike since 2018.

Indicators suggested private consumption in Southeast Asia’s largest economy picked up in the second quarter and could peak in the July-September period at the earliest, he said.

Warjiyo estimated economic growth in the second quarter would be “much higher” than the first quarter’s 5.01%.

Rising demand would put upward pressure on core inflation, which excludes government-controlled and volatile food prices. However, BI’s rate decision would respond to its two-year outlook for core inflation, Warjiyo said.

While core inflation is expected to rise to 2.8% at the end of the year, the level next year would depend on fiscal policy for energy subsidies, to be laid out by President Joko Widodo in mid-August, the governor said.

“If we are to respond with interest rates later on, we won’t be aggressive,” he added.

Indonesia’s inflation hit a five-year high of 4.35% in June, breaching BI’s 2%-4% target range, but core inflation remained low at 2.63%.

Helping keep inflation steady this year has been the government’s $24 billion top up of energy subsidies, using windfall revenues from record exports amid a commodity boom.

The subsidies, as well as export earnings that have propped up the rupiah currency, have provided BI with more space to support growth, even as many global central banks, including the U.S. Federal Reserve, hike rates to battle inflation.

During the pandemic, BI cut interest rates by a total of 150 basis points and injected billions into the financial markets, including though a debt monetisation deal with the government.

Warjiyo stressed that BI has started to roll back some of its pandemic stimulus this year, by reducing excess liquidity, via hikes in the reserve requirement ratio and its open market operations.

BI has also strengthened rupiah stabilisation measures to manage the risk of imported inflation, Warjiyo said, distinguishing this from BI’s previous objective of merely smoothing out exchange rate volatility.

“We’re already ahead of the curve, we’re already starting our normalisation, from liquidity (measures) to mitigating exchange rate pass through,” he said.