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Cablegate: Rising Prices Prompt Interest Rate Increase

VZCZCXRO7218
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0901/01 1280909
ZNR UUUUU ZZH
R 070909Z MAY 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8930
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 1933
RUEHBJ/AMEMBASSY BEIJING 5017
RUEHBY/AMEMBASSY CANBERRA 2458
RUEHUL/AMEMBASSY SEOUL 4569
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 000901

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: RISING PRICES PROMPT INTEREST RATE INCREASE

REF: Jakarta 871

1. Summary. On May 6, the Indonesian central bank - Bank Indonesia
(BI) - increased its reference interest rate by 25 basis points to
8.25% in response to higher than expected inflation in March and
April. BI also signaled that they expect to raise interest rates
further this year. While the 25 basis point increase surprised some
analysts, most macroeconomists in the region felt the rate hike was
overdue. The rate hike is also a sign that the Government of
Indonesia (GOI) plans to implement subsidized fuel price increases
in the near term. While a student led protest of planned fuel price
hikes in Makassar turned violent this week, overall public reaction
to the planned fuel price hike has been subdued. End Summary.


Bank Indonesia Shifts Policy Stance
-----------------------------------

2. Acting BI Governor Miranda Goeltom announced that BI raised its
reference interest (SBI) rate on May 6 by 25 basis point to 8.25% in
an effort to combat rising price levels. Core inflation has been
under significant pressure in recent months due to public
expectation that fuel prices will rise and high global commodity
prices, according to BI. The CPI inflation rate rose to 9.0%
(y-o-y) in April, after jumping to 8.2% (y-o-y) in March. Food
prices, which account for 25% of the CPI basket, rose 15.7% and
13.6% (y-o-y), in April and March, respectively. In its
accompanying policy statement, BI signaled that additional rate
hikes may be forthcoming. They noted that challenges to
macroeconomic stability remain due to rising commodity prices and
the risk of a global economic slowdown.

Market Reaction Generally Positive
----------------------------------

3. Most market analysts had been calling for monetary tightening,
but few expected BI to move prior to incoming BI Governor Boediono's
inauguration on May 17. Analysts had expressed concern in recent
weeks that the GOI was slow to realize the pace at which rising fuel
and food prices were impacting inflationary expectations in
Indonesia. Analyst statements after the interest rate increase
expressed relief that BI is taking the inflation threat seriously.
The market response to the news has been limited, with the
Indonesian stock index rising slightly on May 7.

Fuel Price Increase Will Exacerbate Inflation
---------------------------------------------

4. BI also acknowledged that the rate increase factored in GOI
plans to increase the price of subsidized fuel by as much as 30% in
May or June (reftel). Investors generally view the fuel price
increase positively, as it indicates the GOI is committed to
maintaining fiscal discipline. Public protests of potential fuel
price hikes have been limited to date, although a student protest in
Makassar this week turned violent and resulted in six arrests. The
GOI plans to implement a direct cash transfer program to 19 million
poor households to soften the impact of rising fuel prices.

5. If implemented, the fuel price increase could accelerate broader
price increases this year, as transportation and energy costs for
many sectors rise. HSBC and Standard Chartered expect inflation to
rise to 11 percent this year, if the GOI increases the price of
subsidized fuel by 25-30% and global commodity prices remain high.
Most analysts expect BI to respond by raising interest rates by
100-200 basis points by the end of the year, although political
pressure to limit the impact of higher interest rates on economic
growth will be strong in advance of the election. GDP growth slowed
in the first quarter due to weaker consumption and investment,
according to BI. (Note: The Central Statistics Bureau will announce
the official first quarter GDP growth rate on May 15. End note.)
Aggressive monetary tightening this year, while likely necessary,
will slow growth prospects in 2008 and into 2009.

JAKARTA 00000901 002 OF 002

HUME

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