CENTRAL BANK TENTATIVE AS INFLATION EXPECTATIONS BUILD

UNCLAS SECTION 01 OF 02 JAKARTA 001144 SIPDIS SENSITIVE DEPT FOR EAP/MTS AND EB/IFD/OMA TREASURY FOR IA-SETH SEARLS AND JWEEKS SINGAPORE FOR SBAKER TOKYO FOR MGREWE COMMERCE FOR 4430/KELLY DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN DEPARTMENT PASS EXIM BANK USDA/FAS/OA YOST, MILLER, JACKSON USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER USDA/FAS/OGA CHAUDRY, DWYER E.O. 12598: N/A TAGS: EFIN EAGR ECON PGOV ID SUBJECT: CENTRAL BANK TENTATIVE AS INFLATION EXPECTATIONS BUILD REF: Jakarta 1082 ¶1. (SBU) Bank Indonesia (BI) raised its reference rate by 25 basis points on June 5, signifying a cautious approach to fighting inflation in order to maintain economic growth momentum. Most analysts expected a larger rate hike, given mounting price pressures. Global food and fuel prices are set to remain high this year, providing both challenges and opportunities for Indonesia, according to a World Bank Forum on high international commodity prices. The ability of the Government of Indonesia (GOI) to capitalize on opportunities remains uncertain, according to the experts. End Summary. Central Bank Cautious -------------- ¶2. (SBU) On May 5, BI raised the reference interest rate 25 basis points for the second time this year in response to increased inflation in May. The central bank also moved its reference rate from the 30-day SBI rate to the overnight inter-bank rate as of June 9 to reduce volatility in the overnight market. Most market analysts had expected a larger rate hike, given mounting price pressure (reftel). In the accompanying press statement, BI officials attributed much of the rise in May inflation to external sources. BI Governor Boediono also noted to the press that the central bank will use all monetary tools available to control inflation, including managing exchange-rate volatility. ¶3. (SBU) According to a member of the parliament's (DPR) banking and finance committee (Commission 11),BI plans to raise rates to 9.5% by the end of the year in 25 basis point increments. The plan for slow and steady rate increases contrasts sharply with the central bank's response to inflation in 2005, when BI increased rates by a total of 425 basis points over a five month period. While the recent incrase in subsidized fuel prices is considerably lowe than the increase in 2005, non-fuel inflationar pressures are greater this year than in 2005. I addition, there are signs that inflationary expctations are growing. Local research firm Danarksa's index of inflation expectations rose to its ighest level yet recorded in May, surpassing thelevel in November 2005. ¶4. (SBU) The GOI and th central bank will face a critical test in the cming months as they attempt to tackle inflation an maintain economic growth. A failure to controlinflation is likely to result in a loss of confience from market participants, particularly interational investors. The GOI recently announced plas to raise $1.5 billion in international marketsto finance the buddget deficit. The ability of tee GOI to secure international financing at a reao*nable price will be an important gauge of market sentiment toward Indonesia. In addition, signs ofsslower consumption, the dominant driver of growt in Indonesia over the past 12 months, have emereed. Bank Indonesia's consumer confidence index fel( to a two and a half year low in May, while Danareksa's May consumer confidence index fell to its lowest level since November 2005. Panel Cites Commodity Price Challenges, Opportunities -------------- -------------- ¶5. (U) High global fuel and food prices are unlikely to abate in the short run according to experts at a World Bank-sponsored conference on the impact of high commodity prices in Indonesia. The panelist reported that higher food and fuel prices continue to disproportionately impact the poorest of the poor in Indonesia. The experts urged Indonesia to undertake targeted, conditional cash transfer programs to assist the poor and promote sustainable economic development, rather than the current unconditional cash transfer program or in-kind transfers. The group criticized the GOI's subsidized rice program (RASKIN),arguing that RASKIN is difficult to implement and produces leakages. They pointed out that most poor households can only afford to purchase 6 kg of rice per month, rendering the increase in the amount available to poor JAKARTA 00001144 002 OF 002 households to 15 kg meaningless. ¶6. (U) The forum speakers also noted that Indonesia stands to gain significantly from higher commodity prices, particularly in the agriculture sector. However, those gains depend on the GOI's ability to enable productivity gains in the sector. Restrictive land-use policies, limited access to new agriculture technology, and poor infrastructure inhibit productivity gains in agriculture. The lack of infrastructure in rural communities also exacerbates poverty rates by increasing prices in hard to reach locations. According to the experts, the rice price disparity between regions in Indonesia can be as high as 64 percent. HUME