Indonesia Interest Rate Conundrum as Slowdown Looms

Indonesia’s independent central bank is struggling to maintain its tight monetary policy to combat rising prices.

Bank Indonesia Governor Agus Martowardojo has maintained that the country needs a high interest rate, despite a regional slowdown tied to falling demand in China. Pointing at high inflation rates, the central bank has said it needs to maintain high interest rates to fight inflation and the country’s sizeable current-account deficit.

Indonesia’s independent central bank is struggling to maintain its tight monetary policy to combat rising prices.

Bank Indonesia Governor Agus Martowardojo has maintained that the country needs a high interest rate, despite a regional slowdown tied to falling demand in China. Pointing at high inflation rates, the central bank has said it needs to maintain high interest rates to fight inflation and the country’s sizeable current-account deficit.

However, the government is encouraging the central bank to lower interest rates in an effort to spur growth. Indonesia President Joko Widodo worries that GDP growth in the country is weakening, after data shows first quarter expansion rose only at a 4.7% rate, far below the government’s goal of 7% growth. The country’s vice president, Jusuf Kalla, has also said the central bank will cut its interest rate at a gradual pace to boost domestic demand.

The country has struggled not only with falling oil, but also with falling competitiveness in the energy industry, which used to be a key driver of growth. The country recently became a net importer of energy, which some analysts argue is the result of growing domestic demand and poor infrastructure investment limiting the country’s export potential. Many critics have argued that the country’s continued reliance on the energy sector, yet its failure to boost exports, will be a drag on growth if it cannot diversify its economy. Additionally, the country saw net foreign investment fall by 15% in 2013.

However, the Central Bank is maintaining its stance in defiance of the government’s nudging, insisting that inflation remains a key concern. “Bank Indonesia will maintain a tight monetary stance to anchor inflation expectations and manage external pressures,” Martowardojo said before the nation’s Central Bank meets on May 19th.

Growth with Pain

In recent years, Indonesia has enjoyed one of the highest GDP growth rates in Asia and seen some of the fastest quality of life improvements in Southeast Asia. However, growth slowed from 6.3% in 2012 to 5.8% in 2013 and about 5.1% in 2014, according to World Bank estimates. While far better than much of Asia, the growth rates remain far below neighboring Philippines, Cambodia, Laos, and Vietnam, despite expectations that the country would outperform for a long time.

Indonesia’s growth has also been a double-edged sword, as the country faced rampant inflation that remains unchecked. The country has the highest rate of inflation in Asia, with prices rising 6.8% in April. Inflation has soared in the country since the second half of 2014, peaking at 8.4% in December, even as inflation fell throughout the rest of the world, particularly in Asia. Indonesia’s currency, the rupiah, has lost more value than any Asian currency in 2015. It has lost 5.4% in value so far in 2015.