The level and volatility of Indonesia's inflation rate have historically been higher than in peer emerging nations. Whereas these other emerging markets shared inflationary rates of between three and five percent during the period 2005 to 2014, Indonesia contained an average annual inflation rate of around 8.5 percent over the same period. This section discusses why Indonesia's inflation rate has been high, provides an analysis of recent trends and gives a forecast for future inflation in Indonesia, Southeast Asia's largest economy.
Peaks in Indonesia's inflation volatility correlate with administered price adjustments. Energy prices (fuel and electricity) are set by the government and therefore do not float according to market conditions, meaning that the resulting deficit has to be absorbed by the government's state budget or by state-owned companies Pertamina and Perusahaan Listrik Negara (PLN). This decades-old program puts serious pressure on the government's budget balance while it also limits public spending on more long-term, productive matters, such as infrastructure development or social development. However, since the Joko Widodo administration took office in late-2014, the Indonesian government has successfully scrapped a significant portion of energy subsidies, particularly fuel subsidies.
International institutions such as the International Monetary Fund (IMF) and World Bank criticized the Indonesian government for providing cheap fuel and electricity to its population as the policy causes financial weaknesses (particularly as Indonesia has turned into a net oil importer in the 2000s), limits government investment in more productive sectors (in fact cheap fuel supported the nation's car sales and with infrastructure largely inadequate it resulted in increasingly heavy traffic congestion in the bigger cities of Indonesia), distorts the economy by keeping prices artificially low, and, lastly, it was particularly the middle class that benefited from lower fuel prices, not the poorer segments of Indonesian society (for which it was intended).
Indonesian society became addicted to government subsidies, especially cheap fuel. This meant that attempts to re-arrange energy subsidies implied political risks for the ruling elite as social unrest (demonstrations) emerged inflicted by (the threat of) rising inflationary pressure. One characteristic of Indonesia is that a large quantity of its population is clustered just above the poverty line, meaning that a relatively minor inflationary shock can push them below that line. For example, when the Susilo Bambang Yudhoyono administration (2004-2014) decided to reduce massive fuel subsidies in late 2005 (by raising subsidized fuel prices by more than double) due to the rising international oil price, it soon led to double-digit inflation rates of between 14 and 19 percent (year-on-year) until October 2006. Furthermore, the country's core inflation - which excludes items that are vulnerable to temporary price volatility - has been volatile as well because of second round effects of energy price adjustments that pass through to the broader economy (for example through rising transportation costs).
Indonesia Inflation Rate (annual % change on consumer price index):
Despite social outcry, reduction of Indonesia's energy subsidies remained a top priority on the central government's agenda. In early 2012, the government proposed a fuel price increase but social unrest and political opposition in parliament made a sudden increase impossible. Finally, in June 2013, gasoline was raised by 44 percent to IDR 6,500 (USD $0.66) and diesel by 22 percent to IDR 5,500 (USD $0.56) per liter as the massive fuel subsidies threatened to push the government's budget deficit beyond the three percent of gross domestic product (GDP) level (Indonesian law forbids the budget deficit from exceeding three percent of GDP). In order to support the poorer segments of society, the government engaged in direct cash-handout programs. However, inflation accelerated to 8.4 percent (y/y) by the year-end.
But despite the 2013 price hike, a significant portion of Indonesia's fuel prices remained subsidized, while subsidized fuel demand increased continuously, and therefore the World Bank, IMF and Indonesia's Chamber of Commerce and Industry (Kadin) continued to emphasize the importance to drop the program. After reform-minded Joko Widodo won the presidential election and was inaugurated as Indonesia's seventh president in October 2014, one of the first moves he made was to raise subsidized fuel prices. Gasoline (premium) was raised from IDR 6,500 to IDR 8,500 per liter, while diesel was raised from IDR 5,500 to IDR 7,500 per liter. This meant that the country's inflation pace, which had just started to ease toward Bank Indonesia's target level of 4.5 percent, had no time to recover further and accelerated to 8.4 percent (y/y) again at the end of 2014.
Indonesian Energy Subsidies:
in trillion rupiah
At the start of 2015, President Joko Widodo had the advantage that global petroleum prices had fallen dramatically from mid-2014 due to sluggish global demand while supply was strong due to persistent high oil production figures in the OPEC countries and the US shale gas revolution. Hence, Widodo decided to make a bold move. He basically scrapped gasoline subsidies while setting a fixed IDR 1,000 per liter subsidy for diesel. The Indonesian government still determines the price of gasoline and diesel (adjusted each quarter) but the prices will fluctuate in line with international prices. However, as global petroleum cautiously recovered in the first half of 2015, Indonesian inflation remained high in mid-2015 and only started to ease in late 2015. Bank Indonesia still sees the 2015 inflation at around 4 percent (y/y).
Inflation in Indonesia and Central Bank Target 2008-2016:
(annual % change)
|Bank Indonesia Target
(annual % change)
Sources: World Bank and Bank Indonesia
Inflation in Indonesia:
|Month|| Monthly Growth
| Monthly Growth
| Monthly Growth
| Monthly Growth
Source: Statistics Indonesia (BPS)
Indonesia's characteristic volatile inflation rate causes a traditionally larger deviation from the annual inflation projections of Bank Indonesia. The consequence of such inflationary uncertainty is that it creates economic costs, such as the country's higher (domestic and international) borrowing costs compared to its emerging market peers. When a good track record of meeting annual inflation targets is established, greater monetary policy credibility will follow. But as volatile inflation was primarily caused by subsidized fuel price adjustments, we expect to see less deviation between initial inflation targets and realization.
The lack of quantity and quality of Indonesia's infrastructure also entails high economic costs. It hampers connectivity in the archipelago, thereby increasing transportation costs for services and products (hence causing high logistics costs and making the country's investment climate less attractive). Distribution disturbances due to infrastructure-related issues are frequently reported and made the government realize the importance of investing in the country's infrastructure.
Food prices are highly volatile in Indonesia (vulnerable to weather conditions) and subsequently impose a big burden on those poorer households that live under or just above the poverty line. These households spend more than half of their total disposable income on food items, particularly on rice. Higher food prices therefore cause serious poverty basket inflation which may lead to increases in the level of poverty. Failing harvests in combination with a slow reaction of the government to substitute local food products by imports are causes for inflationary pressure.
Indonesian Inflation per Component (%):
|Instant food, beverages,
cigarettes and tobacco
|Housing, water, electricity,
gas and fuel
and financial services
Source: Statistics Indonesia (BPS)
Traditional Peaks of Inflation in Indonesia
Discarding administered price adjustments, there are two traditional annual peaks of inflation in Indonesia. The December-January period always brings higher prices due to Christmas and New Year celebrations, while the traditional floods in January (amid a peak of the rainy season) result in disrupted distribution channels in several regions and cities, thus causing higher logistics costs. The second inflation peak comes in the July-August period. Inflationary pressures in these two months emerge as a result of the holiday period, the holy Muslim fasting month (Ramadan), Idul Fitri celebrations and the start of the new school year. A marked increase is detectable in spending on food and other consumables (such as clothes, bags and shoes), accompanied by retailers adjusting prices upwards.
Monetary Policy and Bank Indonesia's Benchmark Interest Rate (BI Rate)
With annual GDP growth rising by an average five to six percent (y/y) over the past decade, the economy of Indonesia has been expanding rapidly, characterized by surging domestic demand (domestic consumption accounts for about 55 percent of the country's total economic growth), robust private sector credit growth and increased business access to credit. Moreover, public sector wages have increased due to administrative reforms and private sector wage growth has accelerated (Indonesia's regional minimum wages were raised significantly in 2012-2014). As robust economic growth brings along inflationary pressures, recent monetary policies (since 2013) were aimed at safeguarding the country's financial stability, particularly after inflation surged due to the 2013-2015 subsidized fuel prices reforms while the end of the Federal Reserve's quantitative easing program (and looming higher US interest rates) led to large capital outflows from emerging markets (causing sharply depreciating emerging market currencies), including Indonesia. Bank Indonesia's tighter monetary policy comes at the expense of a higher economic growth pace.
Bank Indonesia has as main objective to ensure rupiah stability. It uses a wide range of instruments to stem mounting inflationary pressures in the country. Its bank rate policy is adjusted when inflation targets are not met. Between February 2012 and June 2013, the country's benchmark interest rate (BI rate) had been set at a historic low of 5.75 percent. After this period, inflationary pressures increased due to subsidized fuel price reforms and global uncertainty about the US monetary policy. Subsequent capital outflows resulted in sharp rupiah depreciation. Therefore, starting from mid-2013, Bank Indonesia adjusted its BI rate upwards gradually yet aggressively from 5.75 percent to 7.75 percent. This move also led to declining credit growth in Indonesia.
As domestic economic fundamentals of Indonesia started to improve, Indonesia's central bank was able to cut its interest rate drastically from a high of 7.75 percent at the start of 2016 to 4.75 percent at the end of 2016 (this also includes the change from the BI rate to the seven-day reverse repo rate as the central bank's benchmark tool).
Another measure to tighten monetary policy was the raising of the reserve requirements on both local and foreign currency deposits at Indonesian banks. Lastly, BI curtailed foreign investors' demand for Central Bank bills (SBIs) by extending the required holding period from one to six months, stretching the maturity of SBI issues to nine months and by introducing longer maturity non-tradable term deposits (which are available to banks only). These measures aimed at mitigating the flow of 'hot money' into Indonesia.
Benchmark Interest Rate of Indonesia 2008-2016:
|Bank Indonesia Rate
(% at year-end)
Source: Bank Indonesia
Indonesian Inflation in Global Perspective
The table below puts Indonesia's recent inflation performance (annual percent change) in global perspective by comparing it to inflation figures of the United States (USA) and China.
Source: World Bank
Updated on 20 January 2017