The Indonesian central bank stopped lowering interest rates in its monthly meeting in early April for a number of reasons: possible further price increases in the coming months; rising inflationary expectations; the fact that inflation has remained persistently high; and worries that adding a monetary stimulus to the economy would only have a limited impact on growth while, at the same time, triggering higher inflation.
Currently the Indonesian long-term inflation rate is around 6 percent. With the impact of the fuel price hikes removed from the inflation data, the current long-term inflation rate is stable at around 6 percent. As such, the perception that inflation is likely to stay at a relatively higher level in the near future is not accurate we believe.
Inflation expectations are abating. dRi’s consumer survey suggests that the increase in price pressures that started to occur in December pushed up consumers’ inflation expectations. But as the harvesting season got underway, however, consumer expectations on prices started to fall in February 2007.
Growth is still below its potential level. Our calculations suggest that the long-term potential growth rate for the Indonesian economy is around 6.7 percent. Job creation at this growth rate is just enough to absorb new job seekers. Thus, as long as the economy grows below 6.7 percent, it is very unlikely that we would see persistent price pressure from the demand side.
The economy still needs a stimulus. Some signs of weaknesses in the Indonesian economy have emerged since December 2006. The readings from the Consumer Confidence Index and the Coincident Economic Index suggest that the current economic conditions might not be as strong as the central bank had previously thought. As such, additional stimuli from the monetary side would not cause the economy to overheat we believe. Download the full report.