Bank Indonesia: A Somewhat Controversial Rate Reduction

February 9, 2012

Bank Indonesia’s benchmark interest rate was cut unexpectedly to 5.75% from 6.0%.  The cumulative decline since October has been 100 bps, and the new rate level is 75 bps lower than the post-Great Recession plateau of 6.50% from August 2009 until a 25-bp hike in February 2011.  That hike was later than the onset of rate normalization in most other Asian economies, and it was the only increase before last October’s cut.  Today’s reduction can only reinforce the dovish reputation of officials at Bank Indonesia.  Their economy grew 6.5% last year, most since before the Asian debt crisis over ten years ago, and the rupiah has lagged behind most Asian currencies.  Inflation could get an upward pop if the government cuts its overly generous energy subsidies, or if the rupiah falls more sharply.

Today’s BI rate cut was the first since November, but a 50-bp cut of the overnight deposit rate was administered last month to 3.75%.

A statement on Bank Indonesia’s website justifies today’s latest easing on several grounds.  Officials are concerned about growth developments in Europe and are not especially thrilled about U.S. prospects, either.  Indonesian CPI inflation fell to 3.65% last month from 3.79% in December and thus resides near the bottom of the bank’s target range of 3.5 – 5.5%.  Officials appear unconvinced that energy price subsidies will be cut significantly in 2012, but the statement indicates a readiness to rethink the assumption about inflation if this assumption proves overly optimistic: "If there is no government policy to reduce fuel subsidy, inflation is predicted to continue decreasing. Bank Indonesia will be vigilant on the impacts of Government policy on energy that may increase pressure on inflation."

The next two Policy Board interest rate announcements will be on March 8 and April 12.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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