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Cablegate: Central Bank Tentative As Inflation Expectations Build

VZCZCXRO6410
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1144/01 1630919
ZNR UUUUU ZZH
R 110919Z JUN 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9264
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 2095
RUEHBJ/AMEMBASSY BEIJING 5132
RUEHBY/AMEMBASSY CANBERRA 2638
RUEHUL/AMEMBASSY SEOUL 4669
RUEAIIA/CIA WASHDC

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

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