The central bank of Indonesia (Bank Indonesia) will not lower its key interest rate (BI rate) until accelerated inflation (brought on by the looming subsidized fuel price hike at the end of the year) has eased and US interest rates are stable (the US Federal Reserve may raise its key interest rate in the second or third quarter of 2015). This implies that the relatively high interest rate environment in Indonesia (the key BI rate has been at 7.50 percent for almost a year) will continue (to safeguard financial stability) at the expense of higher economic growth.
Joko Widodo and the Fuel Subsidies
The new government of Indonesia, led by president-elect Joko Widodo, will be inaugurated in late October 2014. One of the first policy changes that is expected to be conducted by the new government involves Indonesia’s huge fuel subsidies which seem to cause more harm than good.
In the Revised State Budget of 2015 (RAPBN 2015), which was prepared a few weeks ago by the incumbent Susilo Bambang Yudhoyono administration, the government allocated IDR 291.1 trillion (USD $24.7 billion) to fuel subsidies; a figure that is roughly equal to 14.4 percent of total planned government spending in 2015. Joko Widodo, popularly known as Jokowi, immediately reacted to this budget, saying that these subsidies are too high and are in need of reform. Jokowi would like to reduce the subsidies and spend available funds on economic and social development of Indonesia (specifically infrastructure, farmers’ welfare, education and healthcare).
Moreover, expensive oil imports are the main reason why Indonesia has to cope with a wide current account deficit. In the second quarter of 2014, the current account deficit widened to USD $9.1 billion, or, 4.27 percent of the country's gross domestic product (GDP), a level which is generally considered unsustainable and leads to reduced investor confidence. In times of global shocks, which may occur again when the US Federal Reserve decides to raise its key interest rate, Indonesia may therefore be hit harder than other emerging countries.
However, higher subsidized fuel prices will trigger accelerated inflation and thus can push many Indonesians who live just above the poverty line into poverty. Senior Deputy of Bank Indonesia, Mirza Adityaswara, said that a price increase of IDR 1,000 (USD $0.08) per liter for both gasoline (premium) and diesel (solar) can add about 1.1 percentage point to the country’s inflation rate. It remains unknown whether the government will raise these prices and, if raised, by how much it will be raised. Speculation emerged that a price hike of IDR 3,000 per liter is possible. In that case total headline inflation may accelerate to 9 percent (year-on-year).
Indonesia’s Finance Ministry estimates that the government may save IDR 47 trillion (USD $3.9 billion) for every IDR 1,000 (per liter) increase of the subsidized fuel price.
Currently, the price of premium gasoline is IDR 6,500 (USD $0.54) per liter and diesel IDR 5,500 (USD $0.46). In June 2013 the administration of President Susilo Bambang Yudhoyono had raised fuel prices by an average of 33 percent causing year-end inflation of 8.4 percent. Starting from late 2013, however, inflation has shown an easing trend and in August 2014 inflation was recorded at 3.99 percent (year-on-year), indicating that inflation is back under control.
Former Finance Minister of Indonesia Sri Mulyani Indrawati, currently working as a Managing Director at the World Bank, said that Indonesia’s economy can expand over 7 percent per year if fuel subsidies are reduced. Higher economic growth is needed in order to limit the number of poor people in Southeast Asia’s largest economy. She also emphasized that bureaucratic and tax reforms are necessary to improve Indonesia’s economy.
Inflation Forecast September 2014
Indonesia’s September inflation figure will probably be below 0.5 percent (month-to-month) because inflation is traditionally low in the months September and November as inflationary pressures caused by Lebaran, Ramadan and the new school season have vanished. However there are reports that some inflationary pressures can emerge from higher prices of chili, chicken meat and eggs. Furthermore, Pertamina has raised the selling price of liquefied petroleum gas (LPG) by 23 percent (for 12 kilogram LPG canisters). Lastly, after months of dry weather, Indonesia is expected to feel some rain again in September which can impact on distribution networks. Still, inflation is expected to remain low in this month.
Inflation in Indonesia:
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Source: Statistics Indonesia