Pressure for Rate Hike Builds in Indonesia, but No Move Yet

The central bank of Indonesia meets tomorrow and although pressure is building for a rate hike, officials still appear willing to resist for a bit longer.

The economy is growing robustly and Q2 GDP will be out early Thurs local time and is expected to show a 6% annualized expansion, the fastest in a couple of years. At the same time inflation is firming. Last month it stood at 6.22%, up from 5.05% in June and compared with news wires consensus of 5.73%.

So why isn't the central bank raising rates like Korea, Malaysia, India and others ? There appear to be two mitigating factors. First, the rise in inflation is not simply an overheating economy. Electricity taxes were raised for the first time in seven years in July and this is filtering through. And the knock on effect is may increase, according to local reports, over the upcoming religious holiday and festival.

Second, the rupiah has been appreciating and this is tantamount to some degree of tightening. The rupiah is the strongest Asian currency over the past year, rising 12.5% (year-over-year). That is half again as much as the ringgit has risen (which is in second place) and nearly three times the appreciation of the South Korean won and six times the appreciation of the Taiwanese dollar. Year-to-date, the rupiah is the second strongest currency in the region, appreciating about 5.2%. It is currently enjoying the longest advancing streak (today is day 9) in five years.

Like other emerging Asian countries, Indonesia has been the recipient of foreign capital inflows into the equity market. Last month , foreign investors bought $541 mln worth of Indonesian shares, the most in more than three years. In June, the central bank indicated that it was not considering a hike in interest rate. Since then the data suggests the economy may have accelerated a bit and inflation is higher than expected. The currency has been strong. The failure of the central bank to raise rates now might encourage some profit-taking on the currency, which judging from the talk of intervention, might be desirable from an official point of view. However, if growth and inflation remain firm, the risks would increase of a hike next month.