Indonesia's central bank raised interest rates Tuesday for the first time in a year in anticipation of surging inflation after the new government increased the price of subsidised fuel by over 30 percent. At a special meeting called following the price increase, Bank Indonesia raised its key rate by 25 basis points to 7.75 percent, the first rise since November last year and its highest level for more than five years.
President Joko Widodo announced the reduction in government fuel subsidies late Monday, his first major move to strengthen the economy since taking office last month. The government estimates the fuel price rise will lead to about $8 billion of savings in next year's budget, money that Widodo plans to divert to overhauling infrastructure and funding policies to help the poorest. But inflation is expected to jump sharply in the coming weeks as the fuel price rise pushes up the cost of transporting goods, and the central bank's move was aimed at keeping it in check.
"Even though there will be a price increase in the short term, Bank Indonesia... is sure that inflation pressure will remain under control and will be temporary," bank governor Agus Martowardojo said after the more than seven-hour meeting. The bank forecast that inflation will increase to between 7.7 and 8.1 percent by the end of the year. It stood at 4.83 percent year-on-year in October. Despite some concerns that a rate hike could further slow growth, which sank to a five-year low in the third quarter, the bank said it remained confident that its target of 5.1 percent this year would still be achieved.
Economists have welcomed the fuel price increase, with Wellian Wiranto, from OCBC Bank in Singapore, saying the cash spent on subsidies "can now be used to build schools for the young and hospitals for the old, rather than being burned in engines of cars idling in traffic jams". The payouts, which have in the past gobbled up 20 percent of the state budget, are also blamed for a widening current account deficit.