Jakarta – Statistics Indonesia (BPS) announced early this week a 1.17 percent headline inflation in September on a month-to-month basis – the highest since December 2014 – and 5.95 percent year-to-year inflation, while core inflation was 3.21 percent on a YOY basis.

However, the September inflation had not fully absorbed the second round impact of the energy price-hike earlier that month on other goods and services, notably on labor wages. The inflation could rise even higher if the rupiah continues to depreciate, thereby increasing imported inflation with all its multiple negative repercussions on the economy.

Therefore, we will mostly live in a high-inflation episode at least until the first half of 2023 due to the supply shocks to the energy and food sectors and demand-pull price hikes, with headline inflation predicted at between 6.3 and 6.5 percent and core inflation at over 4.5 percent at the end of this year.

But the duration of the current inflation episode will still depend on the supply chain bottlenecks, the central bank response, the duration of the war in Ukraine and its impact on energy and food prices and global growth.

Given the nature of the shocks, with hits coming from both the demand and supply side, Bank Indonesia (BI) faces a dilemma. If BI is too aggressive in money tightening to check inflation, that measure may sabotage the post-pandemic recovery and put pressure on income because economic growth is primarily driven by private consumer spending.

But if the central bank is too dovish, maintaining the policy rate way below the United States rate, especially if the US Federal Reserve continues its aggressive money tightening to reach what it considers as its terminal rate of 4.6 percent, the rupiah will come under tremendous pressure.

BI raised its policy rate by 50 basis points to 4.25 percent last month a few days after the Fed increased its rate by another 75 basis points, its third in a row since March to a range of 3-3.25 percent at present. Most analysts said BI still has room for a rate hike up to 6 percent.

Even though BI has pronounced that it will tie its policy rate primarily to core inflation, the central bank has a track record of raising its rate five times from 4.5 percent in May, 2018 to 6 percent in November 2018 to follow the Fed rate hikes even though our core inflation was 2.70 percent and headline inflation 3.23 percent at that time. The rate hike was made mainly to stabilize the rupiah which depreciated from Rp 13,800 to over Rp 15,000 to the US dollar.

How narrow indeed is the path that policymakers have to navigate. The current situation requires a comprehensive set of demand and supply side measures. On the demand side, a monetary policy must be employed consistently to restore, in a timely manner, price stability. Fiscal policy needs to prioritize medium-term debt sustainability while providing support to most vulnerable groups.

Fortunately, world-wide concerns over a global economic recession have dampened the propensity of consumer spending, pushing down the prices of most commodities, notably energy. This trend alone will significantly influence the behavior of inflation.

Source: https://www.thejakartapost.com/opinion/2022/10/06/high-inflation-episode.htm