Bank Indonesia reported is studying possible hike of benchmark policy rate to deal with inflation

Bank Indonesia (BI) reported is studying possible hike of benchmark policy rate to deal with inflation according to Bisnis Indonesia end of last week. BI governor, Darmin Nasution, said that the central bank will be very careful in hiking the rate, however, if it is necessary BI will not be hesitate to increase it.

Comment: We still see BI rate to stay unchanged at 5.75% this year.

This is due to: First, the current inflationary pressure (5.9% yoy in Mar13) is still mostly driven by the supply shock (volatile food). Meanwhile, demand gauge inflation (core inflation) is relatively stable at 4.2% yoy. The previous chili-driven inflation in 2011 shows that the impacts tends to temporary and normalize after the government boost up the supply through imports. We expect the same trend will happen to the current garlic and onion price after government allow imports; Second, the economic growth momentum is currently easing that will require more accommodative bias monetary policy.

Nevertheless, the prolonged food price normalization that could transpire to core inflation and the delay of fuel subsidy reduction policy could risk on unnecessary monetary policy tightening. The delay in implementing the firm policy to reduce fuel consumption will lead to further pressure on the currency, as the oil and gas trade imbalance will continue to drag down overall trade performance.

Until now, the central bank manages to sustain the equilibrium by strengthening its macro-prudential measure and intervening in FX market. However, it would have to tighten further should the external financing position deteriorating and no improvement in significant improvement.