BI CONTINUES RATE HIKES DESPITE INFLATION DIP

UNCLAS JAKARTA 001694

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA/MALACHY NUGENT
COMMERCE FOR 4430/KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
DEPARTMENT PASS EXIM BANK
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER
USTR WEISEL, EHLERS

E.O. 12598: N/A
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: BI CONTINUES RATE HIKES DESPITE INFLATION DIP


1. (SBU) Summary. On September 4, Bank Indonesia (BI) increased its
overnight reference rate 25 basis points for the fifth consecutive
month, despite a dip in inflation in August. While price increases
slowed in aggregate, food and education prices continued to climb.
Lower world commodity prices eased price pressures but also
contributed to a negative trade balance in July, putting downward
pressure on the Rupiah. In addition to raising the overnight rate,
BI continued to intervene in the foreign exchange market to support
the value of the Rupiah. Foreign exchange reserves fell by $2.2
billion during the month of August. End Summary.

August Inflation Slows, but Food Prices Remain High
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2. (U) Inflation slowed on a month-on-month basis in August,
dropping to 0.51% from 1.37% the previous month, due in large part
to a moderation in the price of global commodities, especially oil.
The yoy inflation rate now stands at 11.85%. Domestic food and
education prices continued to rise in August, accounting for the
bulk of the month-on-month price increase. Food prices have
increased 20.1% since August 2007. Prices of protein-rich foods
such as poultry and eggs continued to soar in August due to high
feed costs, bringing their year-to-date increase to 70.7% and 27.0%,
respectively. Wholesale prices have increased at a faster pace than
consumer prices. According to the most recent published data, the
wholesale price index jumped 6.0% month-on-month from May to June,
bring the year-on-year wholesale inflation rate in June to 35.0%.

BI Continues to Tighten
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3. (SBU) BI continued to tighten monetary policy in September and
signaled the use of multiple monetary tools, in moves applauded by
most analysts. Despite slower price increases in August, BI
increased its overnight reference interest rate to 9.25% from 9.0%,
citing ongoing inflationary pressures from strong domestic demand.
Key concerns include the rapid growth in bank credit (35%
year-on-year as of mid-August) and the surge in imports (52.3%
year-on-year in June). Analysts also note that wholesale firms have
not yet fully passed on price increases to consumers. As in
previous months, BI hinted at plans to raise reserve requirements to
slow loan growth in the coming months.


4. (SBU) BI also continues to intervene in the foreign exchange
market, using $2.2 billion in foreign exchange reserves to defend
the value of the Rupiah in August alone. Indonesia's foreign
exchange reserves currently stand at $58.4 billion. Indonesia
recorded a trade deficit in July due to strong demand for imports
and declining world prices for Indonesia's commodity exports.
Analysts expect these trends to continue, putting downward pressure
on the currency and triggering additional intervention from BI to
control imported inflation. Investors are likely to pay close
attention to Indonesia's foreign exchange reserve levels and trends
as an indicator of balance of payments and macroeconomic stability
in the coming months. Indonesia recorded an overall balance of
payments surplus of $1.3 billion in the second quarter of 2008;
however, short-term capital inflows were the primary driver of the
surplus.

HUME