Dion Bisara – After months of pressure from the market and economists, Bank Indonesia on Friday raised its benchmark interest rate by a quarter percentage point to 6.75 percent, citing growing inflationary pressures.
"It was raised by 25 basis points," Deputy Governor Halim Alamsyah said at the central bank's headquarters in Central Jakarta after Friday prayers.
"The decision was taken as an anticipative measure to control inflation expectation that we see increasing," said an official statement distributed shortly after Halim's comments.
"The increasing expectation is due to still highly volatile food prices, along with a rise in the price of global commodities and government policies in strategic commodities."
Friday's rate hike was the country's first in almost two years. Bank Indonesia had kept its benchmark rate at 6.5 percent since August 2009 – the lowest level since it was introduced in July 2005 – to boost economic growth and on fears that an increase would attract more hot money flows into the country.
Other countries in the region, including India, Australia, Malaysia and Thailand, have already raised their rates.
The consumer price index rose 7.02 percent year-on-year in January, more than the market expectation of 6.81 percent, due to food shortages caused by harvests being spoiled by a long wet season.
Fearing inflation could accelerate even further this year, economists and market analysts had been calling on the central bank to take more hawkish measures. Bank Indonesia on Friday said it would maintain its inflation target at between 4 percent and 6 percent this year.
Eric Alexander Sugandi, a Jakarta-based economist with Standard Chartered Bank, said the central bank had wanted to send a strong signal.
"Bank Indonesia wants to show the market that they are concerned about inflation," he said.
Helmi Arman, an economist at Bank Danamon, agreed, saying the market should be mindful that the rate increase was meant to anchor expectations and help prevent any dramatic outflow of capital.
Eric said the increase in the rate was likely to attract more capital inflows to Indonesia, with the spread between the US Federal Reserve's key interest rate and Bank Indonesia's rate becoming even wider.
"This would increase the cost of market sterilization by the central bank," he said, adding that the capital inflow could also boost the rupiah, helping curb inflation from the import side.
Both Eric and Helmi expect Bank Indonesia to lift the rate again in the coming months to further contain inflation, with Eric suggesting a 75 basis point increase to lift the policy rate to 7.5 percent by the end of the year. Helmi said he expected another hike of 50 basis points, which would take the policy rate to 7.25 percent.