Daiwa: Indonesia Economy-Inflation above BI's target range

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Indonesia Economy   
With inflation above BI's target range again, we believe a rate hike is inevitable


Summary
• Foreign reserves continue to expand faster than base money, so monetary policy
seems on a sustainable track. But with CPI inflation rising well above 6% YoY
in November, we think a policy-rate hike is likely within a month from now.


Fundamentals
• Indonesia’s CPI inflation rose to 6.3% YoY for November, the third time in the past
five months that inflation has been above 6% YoY. The spike in inflation was
caused mainly by rising food inflation (12.3% YoY for November, up from 9.8%
YoY for October). Core inflation rose to 4.3% YoY for November, a marginal
increase from 4.2% YoY for October. Bank Indonesia (BI)  has not changed the
policy rate since the 25bp rate cut in August 2009, and remains one of only two
central banks in Asia (the other being the Philippines’ BSP) not to have raised rates
in 2010. The Philippines’ inflation has moderated to 2.8% YoY. But Indonesia has
a 4%-6% target range for headline inflation, so we think a policy-rate increase is
needed to maintain the credibility of its inflation target.  
• BI governor Darmin Nasution (since taking effective charge in late-July 2010,
and formally taking over on 1 September) has been reluctant to raise interest
rates – preferring to use several other policy tools that sent contradictory
messages. He instructed each bank to raise its loan-deposit ratio (LDR) above
78% by March 2011, failing which they would have to pay a penalty. While
banks with an LDR above 100% would also be penalised, three large banks are
well below the 78% threshold and none are above 100%, suggesting a bias
toward faster loan growth. Banks’ minimum reserve requirements, however,
were raised to 8% (from 5%) on 1 November – and the tightening of liquidity is
evident in the fact that Indonesia’s foreign reserves are growing faster than base
money (left chart), which we consider a crucial indicator of monetary
credibility. However, we believe that the latest print on headline inflation
requires a 25bp policy-rate hike soon. Given Governor Nasution’s previous
approach, BI may wait another month before raising rates, but we think a rate
hike is inevitable either tomorrow or no later than next month.