Economy BI kept policy rate unchanged at 6.75% yesterday. We suspect that monetary tightening will become a more pressing issue by 4Q - DBS

In line with market and our expectations, the central bank (BI) kept its policy rate unchanged at 6.75% yesterday. Indonesia is currently in a sweet spot with declining headline inflation amid robust economic growth. Moreover, the long-delayed hike in fuel prices looks unlikely to materialize this year as the government appears more intent on keeping inflation low through higher allocation to fuel subsidies. Accordingly, this implies that headline inflation is likely to grind lower through the rest of the year, allowing BI more leeway to hold off on monetary tightening. As such, we also see downside risks to our 6.7% inflation forecast as well as our call for 3 more 25bps rate hikes for the year.
Beyond the short term, demand-pull inflation will become an issue, necessitating further increases in the policy rate. The strength of the Indonesian economy is apparent and growth momentum has and will continue to be strong in the coming quarters. By keeping borrowing costs low and fuel prices depressed, the economy may soon be in danger of overheating if monetary tightening is not resumed. To be sure, core inflation has been ticking up steadily, along with the concomitant uptrend in loan growth and money supply growth. While these are signs of growth in the economy, they also herald higher inflation down the line. We suspect that monetary tightening will become a more pressing issue by 4Q11.