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Cablegate: Bi Hikes Policy Rate in Response to July Inflation

VZCZCXRO3516
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1487/01 2180903
ZNR UUUUU ZZH
R 050903Z AUG 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9708
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2316
RUEHBJ/AMEMBASSY BEIJING 5264
RUEHBY/AMEMBASSY CANBERRA 2860
RUEHUL/AMEMBASSY SEOUL 4786
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 001487

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 HIKES POLICY RATE IN RESPONSE TO JULY INFLATION

1. (SBU) Summary. Bank Indonesia (BI) raised its policy rate 25
basis points for the fourth consecutive month to 9.0 percent in
response to higher than expected inflation. July inflation
increased 1.37 percent (mom) and 11.9 percent (yoy), due mainly to
higher food, housing and utility prices. The year-on-year increase
in unprocessed food in July rose to 19.9 percent. Recent surveys
indicate that rising food prices continue to strain household
budgets and have forced a number of Indonesians to change
consumption patterns. BI officials continue to favor measured rate
hikes over more dramatic monetary tightening in an effort to
maintain growth momentum in Indonesia, but pressures on prices
remain in place. While BI's rate hike was in line with market
expectations, some analysts note that the current pace of rate hikes
may be insufficient to anchor inflation expectations. End summary.


Food Prices Drive July Inflation
--------------------------------

2. (SBU) The headline inflation rate rose 11.9 percent (yoy) in
July, exceeding market expectations and the 11.03 percent recorded
in June. The yoy number is likely understated due to the Government
of Indonesia's (GOI) decision to alter the inflation basket and
rebase the index last month. Consumer prices rose 1.37 percent
compared to the previous month, due mainly to rising food prices.
The rise in processed and unprocessed food prices accounted for over
40 percent of the month-on-month increase. Increases in housing and
utility costs accounted for an additional 33 percent of monthly CPI
rise, reflecting the impact of higher fuel costs. [Note: The
Central Statistics Bureau (BPS) has not released a historical CPI
time series or a core inflation figure since adopting the revised
methodology in June. End note]

3. (U) Rising prices of staple food products continue to strain
household budgets. According to data from the Center for Market
Information at the Ministry of Trade, the price of rice, which
accounts for as much as one-third of the budget of low income
households, fell slightly between June and July due to the current
harvest. However, rice prices are up 16.4% over the same period
last year. The price of eggs and poultry soared in July, increasing
12.8 percent and 3.5 percent, respectively, over the previous month.
Egg and poultry prices have increased 45.6 percent and 75.9
percent, respectively, since July 2007, due to historically high
feed costs. The price of flour, soybeans, and instant noodles
continued to rise in July, bringing the year-on-year increase to
60.7 percent, 30.9 percent, and 28.1 percent, respectively.

4. (SBU) Recent analysis indicates that rising food and fuel prices
are forcing a number of Indonesians to change consumption patterns.
The GOI cash transfer program and rice subsidy scheme have offset
much of the May fuel price hike among poor households, according to
World Bank staff. Yet, a recently issued Gallup Poll conducted in
March 2008 revealed that standards of living across a large portion
of Indonesia's population had eroded significantly before the fuel
price increase. According to the Gallup Poll, 4 out of 10
Indonesians said their standard of living was declining and that it
was difficult or very difficult to live on their current salary. A
Roy Morgan Poll in May 2008 also found that roughly 40 percent of
the population has switched to cheaper and/or lower quality foods in
response to higher food prices. Roughly 16 percent of the
population has cut the amount of food consumed in response to higher
prices, according to the Roy Morgan report.

BI Hikes Rates Modestly
-----------------------
5. (U) On August 5, Bank Indonesia raised its policy rate 25 basis
points to 9.0 percent, continuing its policy of measured interest
rate hikes to control mounting inflation expectations. In addition
to pressure on food prices, the central bank noted in its policy
statement that demand side pressure on prices continues to mount.
Credit expansion continued at a robust pace through May 2008,
increasing over 3 percent (mom) and more than 30 percent (yoy).

JAKARTA 00001487 002 OF 002


Moreover, while GDP numbers for the second quarter have not been
released, the BI policy statement noted that motor vehicles and
cement sales remain robust, pointing to continued strong domestic
demand in the second quarter. In an effort to control imported
inflation, traders report that BI is also intervening in foreign
exchange markets to increase the value of the Rupiah. The Rupiah is
currently trading at a four month high at roughly RP/USD 9050.
Although BI is active in exchange rate management, foreign exchange
reserves remain high, at over $60 billion. BI officials are
reportedly considering raising the reserve requirement for banks in
an effort to slow credit growth.

6. (SBU) Despite BI's multipronged approach to fighting inflation,
some analysts are concerned that the current pace of rate hikes is
insufficient to anchor inflation expectations. According to IMF
estimates, BI may need to raise interest rates to 10.5% in order to
reverse current price trends and keep rising food and fuel prices
from spilling over into core inflation. IMF economists also note
that excessively slow interest rate hikes may lead to a loss of
credibility at the central bank and will not prevent the need for
further rate hikes. Furthermore, a recent JP Morgan report noted
that Indonesia's current account surplus may be lower than initially
recorded. If the trade surplus is overstated, capital flows are
likely playing a significant role in supporting Indonesia's balance
of payments position, leaving Indonesia more vulnerable to a reverse
in portfolio investor sentiment. A loss of confidence among
investors that leads to significant capital outflow would put
significant pressure on the currency and fuel domestic price
increases.

HUME

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