inflation in Indonesia

INFLATION

 Level and volatility of Indonesia's inflation rate have historically been higher than some peer emerging nations. While these other countries share inflationary rates of between three and five percent during the period 2005 - 2012, Indonesia contains an average annual inflation rate of around 8.5 percent during the same period. There is, however, a more moderating trend visible since 2009 (see graphic below).

        Indonesia Inflation Rate (annual percentage change on consumer price index)

     

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 subsidies. This puts serious pressure on the government's annual budget deficit and also limits public spending in more long-term productive matters, such as infrastructure and social expenditures. Moreover, rearranging energy subsidies implies political risks as social unrest emerges inflicted by inflationary pressures. 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. When the Susilo Bambang Yudhoyono administration decided to reduce its massive fuel subsidies in late 2005 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 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).

Reduction of energy subsidies is currently still high on the 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. Indonesia's current inflation outlook is highly influenced by the decision to reduce these subsidies. The World Bank estimates that an IDR 1,500 increase in fuel prices can add 3.2 percentage points to the level of headline inflation and can add 1.3 percentage points to core inflation.

The table below presents Indonesia's recent performance and near-future projections regarding inflation (these projections are based on the scenario with no reduction in energy subsidies).

The table below presents Indonesia's recent performance and near-future projections regarding inflation (these projections are based on the scenario with no reduction in energy subsidies).

	2008	2009	2010	2011	2012	2013
Inflation (annual percent change)	9.8	4.8	5.1	5.4	4.3	5.5¹

^{¹ indicates a forecast
Source: World Bank}

Indonesia's characteristic volatility in inflation rate causes an usually larger deviation from the annual inflation projections. The consequence of such inflationary uncertainty is that it creates economic costs such as the country's current higher (domestic and international) borrowing costs than its emerging market peers. When a track record of meeting inflation targets is established, greater monetary policy credibility will follow.

The lack in quantity and quality of Indonesia's infrastructure also entails robust economic costs. This hampers connectivity in the archipelago, thereby increasing transportation costs for services and products. Distribution disturbances due to infrastructure-related issues are frequently reported and made the government realize the importance of more investments in the country's infrastructure. Infrastructure has been labelled a top priority in the Masterplan for Acceleration and Expansion of Indonesia's Economic Development (abbreviated MP3EI); an ambitious long-term government development plan which is yet to bear fruit.

Food prices are traditionally highly volatile in Indonesia and subsequently impose a big burden on the poorer households who live under or just above the poverty line. These households spend more than half of their total expenditure on food items. 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 food products with food imports are causes for inflation peaks.

The Ramadan or fasting month (the ninth month of the Islamic calender) usually constitutes a peak in inflation. This is a normal phenomenon in other countries with large Muslim communities as well. A marked increase is visible in spending on food and other consumables, accompanied by retailers adjusting their prices upwards.

The current strength of Indonesian domestic demand (domestic consumption accounts for around two thirds of the country's economic growth), robust private sector credit growth and business access to credit can lead to inflationary pressures in 2012 and beyond. Public sector wages have increased due to administrative reforms and private sector wage growth has accelerated in the agricultural and mining sectors (and the minimum wage in Jakarta has been raised by 40 percent in late 2012). In combination with the anticipated reduction in energy subsidies, it is likely that inflationary pressures will rise.

Bank Indonesia (BI), Indonesia's central bank, 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. Since June 2009 the central bank rate has been steady between 5.75 and 7.0 percent (constituting a historic low) as targets were met. The spikes in headline inflation since 2009 have mainly been caused by weather conditions that resulted in bad harvests, thus being temporary disruptions only. Another BI 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 aim at mitigating the flow of 'hot money' into Indonesia.

Bank Indonesia's Inflation Targets

2012	4.5% (±1%)
2013	4.5% (±1%)
2014	4.5% (±1%)
2015	4.0% (±1%)

^{Source: Bank Indonesia}

Indonesian Inflation in World Perspective

The table below puts Indonesia's recent inflation performance (annual percent change) in global perspective by comparing it to inflation figures from the United States (USA) and China.

	2009	2010	2011	2012	2013
USA	-0.4	1.6	3.2	2.1	-
China	-0.7	3.3	5.4	2.6	-
Indonesia	4.8	5.1	5.4	4.3	5.5¹