Mirza Adityaswara, Senior Deputy Governor of Bank Indonesia, says the main challenges this year - in terms of inflation - originate from administered price adjustments, including the gradual electricity tariff hikes. In the January-February 2017 period electricity prices for 900-VA households rose 31 percent. In the second phase of the program, in March 2017, prices are raised by 32.7 percent. Lastly, in the May-June 2017 period electricity prices will increase by 42.9 percent. Afterwards, starting from 1 July 2017, these 900-VA subscribers group will be subject to an auto-adjusted electricity tariff scheme just like the other 12 non-subsidized customer groups.

The Joko Widodo-led government has been eager to cut energy subsidies (fuel and electricity) in order to use public funds for more productive matters such as infrastructure and social development programs as well as to ensure that state subsidies indeed go to the poorer segments of Indonesian society. Rather than using direct cash-transfer programs (which easily flow into the pockets of lower government officials), the government also focuses on the distribution of cheap - or free - products such as rice and sugar to the nation's poor.

Bank Indonesia welcomes the central government's efforts to curtail energy subsidies (and re-direct the available funds to structural economic and social development of Indonesia), which would also make the government's fiscal balance sheets healthier (hence the rupiah becomes stronger), but warns that inflationary pressure from administered price adjustments are rising. This year the central bank of Indonesia targets inflation in the range of 3 - 5 percent year-on-year (y/y), while the government set its inflation target at 4 percent (y/y) in the 2017 State Budget. According to the latest data from Statistics Indonesia (BPS), Indonesian inflation accelerated to 3.83 percent (y/y) in February 2017. For Indonesian standards this inflation figure is still very low.

The positive news, according to Adityaswara, is that inflationary pressures from volatile food products (the other main source of inflation in Indonesia besides administered price adjustments) is on the decline. He emphasized the central and regional governments as well as the related ministries need to optimize cooperation and coordination in order to ensure a conducive supply side (for example ample supply of agricultural commodities or meat) as well as a conducive distribution network in order to limit inflationary pressures from volatile food products.

Due to weak infrastructure and non-optimal production techniques of local farmers, production volumes of crops tend to be below their potential in Indonesia, while logistics costs are high and distribution channels are easily blocked in times of bad weather. These circumstances explain why Indonesia's inflation level is structurally above the inflation levels of neighboring countries. While nations such as the Philippines, Malaysia, and Thailand can manage to keep inflation within the range of 1 - 3 percent (y/y), inflation in Indonesia averaged in the range of 5 - 6 percent (y/y) over the past decade (particularly caused by fuel subsidy cuts). However, since 2015 there has been a marked improvement in Indonesian inflation to the range of 3 - 4 percent (y/y).

Still, Adityaswara emphasizes Indonesia needs to curb inflation further in order to enjoy a low interest rate environment. However, this would also require a further improvement in the country's current account deficit.

In the first month of 2017 Indonesia's monthly inflation level was rather high at 0.97 percent (m/m) because not only the electricity tariff was raised but also fuel prices and vehicle registration fees rose. We do not expect to see such big inflation in March 2017 because in terms of administered prices only the electricity tariff for 900-VA households will rise. Moreover, starting from March the harvesting season starts in Indonesia, implying food prices should remain stable.

Inflation in Indonesia:

Month M/M Growth
M/M Growth
M/M Growth
M/M Growth
M/M Growth
January      1.03%      1.07%     -0.24%      0.51%      0.97%
February      0.75%      0.26%     -0.36%     -0.09%      0.23%
March      0.63%      0.08%      0.17%      0.19%
April     -0.10%     -0.02%      0.36%     -0.45%
May     -0.03%      0.16%      0.50%      0.24%
June      1.03%      0.43%      0.54%      0.66%
July      3.29%      0.93%      0.93%      0.69%
August      1.12%      0.47%      0.39%     -0.02%
September     -0.35%      0.27%     -0.05%      0.22%
October      0.09%      0.47%     -0.08%      0.14%
November      0.12%      1.50%      0.21%      0.47%
December      0.55%      2.46%      0.96%      0.42%
Total      8.38%      8.36%      3.35%      3.02%

Source: Statistics Indonesia (BPS)

Inflation in Indonesia and Central Bank (BI) Target 2008-2016:

  2008 2009 2010 2011 2012 2013 2014 2015 2016
(annual % change)
 9.8  4.8  5.1  5.4  4.3  8.4  8.4  3.4  3.0
BI Target
(annual % change)
 5.0  4.5  5.0  5.0  4.5  4.5  4.5  4.0  4.0

Source: Bank Indonesia