Indonesia Keeps Benchmark Interest Rate at Record Low, Risking Credibility

Bank Indonesia kept its benchmark interest rate at a record low, putting its inflation-fighting credibility at risk as it judges the economy can cope with accelerating price gains.

The central bank maintained its reference rate at 6.5 percent for a 16th meeting, it said in Jakarta today. All 20 economists surveyed by Bloomberg News had expected the decision. The measure is at the lowest level since its introduction in July 2005.

“Bank Indonesia is risking being behind the curve,” said Vishnu Varathan, an economist at Capital Economics in Singapore. “Inflation is picking up faster than anticipated. Monetary policy acts with a lag and Bank Indonesia wouldn’t want inflation expectations to become unanchored.”

Indonesia has avoided raising interest rates this year even as a regional rebound prompted moves by China, India, Malaysia, South Korea, Thailand and Taiwan, whose benchmarks are lower. The central bank, which has ordered lenders to set aside larger reserves to rein in liquidity without hurting economic expansion, said today it may regulate rupiah bank accounts held by non- residents to mitigate the impact of capital inflows.

“Questions will persist as to how much longer the rate would stay at 6.5 percent if inflation were to continue inching higher,” Gundy Cahyadi, an economist at Oversea-Chinese Banking Corp. in Singapore, said before the decision. “This may trigger some credibility issues eventually.”

Inflation Accelerates

Indonesia’s consumer prices rose 6.33 percent last month from a year earlier, the Central Bureau of Statistics said Dec. 1, exceeding all estimates in a Bloomberg News survey of 20 economists. The gain compared with a 5.67 percent increase in October.

Thailand has boosted borrowing costs three times this year, most recently this week, matching the number of moves by Bank Negara Malaysia. Singapore’s central bank, which uses the exchange rate to manage inflation, has tightened its monetary stance twice this year, revaluing its currency in April and saying it would allow faster currency gains.

China, which raised rates in October, will shift to a “prudent” monetary policy next year from a relatively loose stance, Xinhua News Agency reported today, citing a work meeting of Political Bureau of the Communist Party of China Central Committee.

Capital Flows

Bank Indonesia has delayed a rate increase that could attract more funds at a time when emerging markets are luring investors away from developed economies. The Jakarta Composite Index has gained 46 percent this year, boosting stocks of companies including lender PT Bank Central Asia and noodle-maker PT Indofood Sukses Makmur. The rupiah has risen more than 4 percent against the dollar.

Bank Indonesia may regulate so-called vostro accounts, or rupiah current accounts held by non-residents in domestic banks, the central bank said in a statement today.

“By using the vostro accounts, there is an implicit acknowledgement that they need to hike rates to tackle inflation without getting distracted by other issues, which must be handled by other policy tools,” Varathan said.

The benchmark interest rate is “consistent” with the central bank’s inflation target, Bank Indonesia said. The pace of price increases may exceed 6 percent “slightly” by the end of the year, it said.

Inflation Focus

Consumer-price gains in 2011 will probably be above the central bank’s goal and there is a “material chance” that inflation may reach as high as 8 percent in the next three to six months, Cahyadi said.

Concern global growth will falter has prompted neighboring Malaysia to pause after raising interest rates earlier this year. Ireland last month became the second euro country to get a bailout in a revival of sovereign credit woes in Europe. Federal Reserve Chairman Ben S. Bernanke said this week the U.S. economy isn’t growing fast enough to “materially” reduce unemployment that is above 9 percent.

Thai Finance Minister Korn Chatikavanij said yesterday the unexpected Bank of Thailand rate increase on Dec. 1 is a concern for economic growth, which slowed last quarter. Indonesia’s economic expansion also eased in the three months through September to 5.8 percent.

Bank Indonesia Governor Darmin Nasution has ordered lenders to set aside larger reserves, aiming to rein in as much as 50 trillion rupiah ($5.6 billion) of excess liquidity. From Nov. 1, Indonesian banks were required to set aside 8 percent of their deposits as primary reserves from 5 percent previously.

The central bank also unveiled measures earlier this year to encourage investors to keep their money in the country longer and reduce volatility in capital flows and the currency.

“Having these measures in place to mitigate some of the capital inflows would give Bank Indonesia the relative comfort zone to re-focus on their primary monetary policy tool kit, that of the policy rate, to counter Indonesia’s inflation concerns,” said Wellian Wiranto, an HSBC Holdings Plc economist in Singapore. “We continue to expect the central bank to hike rates starting from January 2011.”

To contact the reporters on this story: Shamim Adam in Singapore at sadam2@bloomberg.net; Novrida Manurung at nmanurung@bloomberg.net

To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net

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