Economy BI is expected to keep rates unchanged at 6.75% today, after headline inflation recently eased to 6.7%. BI would remain vigilant against inflation in the statement - DBS Vickers

Bank Indonesia is widely anticipated to leave rates unchanged for the second consecutive month at 6.75% at today’s monetary policy meeting. CPI inflation eased to 6.7% YoY in March from 6.8% in Feb and the peak of 7.0% in Jan, thanks to the downward correction in food prices based on harvest arrival. The head of the statistics agency said on April 6th that prices of basic food such as rice may have declined continuously this month. And the government has also confirmed to maintain fuel subsidies to avoid a jump in oil price inflation. To reflect lower-than-expected headline inflation pressures in the short term, we have removed one hike from the interest rate forecast for 2Q. The rate target for mid-year and end-year is accordingly revised to 7.0% (from 7.25%) and 7.5% (from 7.75%) respectively, while the longer-term target is kept unchanged at 8.0% for 1Q12.

Nonetheless, we think BI would remain vigilant against inflation during the policy statement to be released tomorrow. Core inflation has risen to a 17-month high of4.5% YoY as of March. We expect core inflation to continue the upward trend in the remainder of this year and reach 5% by the year-end, in accordance with strong economic growth (the output gap widened to over 1% of GDP in 4Q10),accommodative liquidity condition (M2 quickened to 17% since 1Q11), and expansionary fiscal policy (due to the extension of fuel subsidies).

Inflation management is also closely watched by rating agencies when deliberating whether to upgrade Indonesia ’s sovereign credit rating to the investment grade. Last Friday S&P raised Indonesia’s long-term foreign currency sovereign rating to BB+ from BB and affirmed local currency rating at BB+, citing the improvement in government debt ratios and growing foreign reserves. According to S&P, an upgrade to the investment level would be based on diminishing inflation pressures, declining external debt burden, or structural economic reforms such as subsidy rationalization.