VZCZCXRO3516
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1487/01 2180903
ZNR UUUUU ZZH
R 050903Z AUG 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9708
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2316
RUEHBJ/AMEMBASSY BEIJING 5264
RUEHBY/AMEMBASSY CANBERRA 2860
RUEHUL/AMEMBASSY SEOUL 4786
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 001487 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA/MALACHY NUGENT 
COMMERCE FOR 4430/KELLY 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN 
DEPARTMENT PASS EXIM BANK 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
USDA/FAS/OA YOST, MILLER, JACKSON 
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER 
USDA/FAS/OGA CHAUDRY, DWYER 
USTR WEISEL, EHLERS 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: BI HIKES POLICY RATE IN RESPONSE TO JULY INFLATION 
 
¶1. (SBU) Summary.  Bank Indonesia (BI) raised its policy rate 25 
basis points for the fourth consecutive month to 9.0 percent in 
response to higher than expected inflation.  July inflation 
increased 1.37 percent (mom) and 11.9 percent (yoy), due mainly to 
higher food, housing and utility prices.  The year-on-year increase 
in unprocessed food in July rose to 19.9 percent.  Recent surveys 
indicate that rising food prices continue to strain household 
budgets and have forced a number of Indonesians to change 
consumption patterns.  BI officials continue to favor measured rate 
hikes over more dramatic monetary tightening in an effort to 
maintain growth momentum in Indonesia, but pressures on prices 
remain in place.  While BI's rate hike was in line with market 
expectations, some analysts note that the current pace of rate hikes 
may be insufficient to anchor inflation expectations.  End summary. 
 
 
Food Prices Drive July Inflation 
-------------------------------- 
 
¶2. (SBU) The headline inflation rate rose 11.9 percent (yoy) in 
July, exceeding market expectations and the 11.03 percent recorded 
in June.  The yoy number is likely understated due to the Government 
of Indonesia's (GOI) decision to alter the inflation basket and 
rebase the index last month.  Consumer prices rose 1.37 percent 
compared to the previous month, due mainly to rising food prices. 
The rise in processed and unprocessed food prices accounted for over 
40 percent of the month-on-month increase.  Increases in housing and 
utility costs accounted for an additional 33 percent of monthly CPI 
rise, reflecting the impact of higher fuel costs. [Note:  The 
Central Statistics Bureau (BPS) has not released a historical CPI 
time series or a core inflation figure since adopting the revised 
methodology in June. End note] 
 
¶3. (U) Rising prices of staple food products continue to strain 
household budgets.  According to data from the Center for Market 
Information at the Ministry of Trade, the price of rice, which 
accounts for as much as one-third of the budget of low income 
households, fell slightly between June and July due to the current 
harvest.  However, rice prices are up 16.4% over the same period 
last year.  The price of eggs and poultry soared in July, increasing 
12.8 percent and 3.5 percent, respectively, over the previous month. 
 Egg and poultry prices have increased 45.6 percent and 75.9 
percent, respectively, since July 2007, due to historically high 
feed costs.  The price of flour, soybeans, and instant noodles 
continued to rise in July, bringing the year-on-year increase to 
60.7 percent, 30.9 percent, and 28.1 percent, respectively. 
 
¶4. (SBU) Recent analysis indicates that rising food and fuel prices 
are forcing a number of Indonesians to change consumption patterns. 
The GOI cash transfer program and rice subsidy scheme have offset 
much of the May fuel price hike among poor households, according to 
World Bank staff.  Yet, a recently issued Gallup Poll conducted in 
March 2008 revealed that standards of living across a large portion 
of Indonesia's population had eroded significantly before the fuel 
price increase.  According to the Gallup Poll, 4 out of 10 
Indonesians said their standard of living was declining and that it 
was difficult or very difficult to live on their current salary.  A 
Roy Morgan Poll in May 2008 also found that roughly 40 percent of 
the population has switched to cheaper and/or lower quality foods in 
response to higher food prices.  Roughly 16 percent of the 
population has cut the amount of food consumed in response to higher 
prices, according to the Roy Morgan report. 
 
BI Hikes Rates Modestly 
----------------------- 
¶5. (U) On August 5, Bank Indonesia raised its policy rate 25 basis 
points to 9.0 percent, continuing its policy of measured interest 
rate hikes to control mounting inflation expectations.  In addition 
to pressure on food prices, the central bank noted in its policy 
statement that demand side pressure on prices continues to mount. 
Credit expansion continued at a robust pace through May 2008, 
increasing over 3 percent (mom) and more than 30 percent (yoy). 
 
JAKARTA 00001487  002 OF 002 
 
 
Moreover, while GDP numbers for the second quarter have not been 
released, the BI policy statement noted that motor vehicles and 
cement sales remain robust, pointing to continued strong domestic 
demand in the second quarter.  In an effort to control imported 
inflation, traders report that BI is also intervening in foreign 
exchange markets to increase the value of the Rupiah.  The Rupiah is 
currently trading at a four month high at roughly RP/USD 9050. 
Although BI is active in exchange rate management, foreign exchange 
reserves remain high, at over $60 billion.  BI officials are 
reportedly considering raising the reserve requirement for banks in 
an effort to slow credit growth. 
 
¶6. (SBU) Despite BI's multipronged approach to fighting inflation, 
some analysts are concerned that the current pace of rate hikes is 
insufficient to anchor inflation expectations.  According to IMF 
estimates, BI may need to raise interest rates to 10.5% in order to 
reverse current price trends and keep rising food and fuel prices 
from spilling over into core inflation.  IMF economists also note 
that excessively slow interest rate hikes may lead to a loss of 
credibility at the central bank and will not prevent the need for 
further rate hikes.  Furthermore, a recent JP Morgan report noted 
that Indonesia's current account surplus may be lower than initially 
recorded.  If the trade surplus is overstated, capital flows are 
likely playing a significant role in supporting Indonesia's balance 
of payments position, leaving Indonesia more vulnerable to a reverse 
in portfolio investor sentiment.  A loss of confidence among 
investors that leads to significant capital outflow would put 
significant pressure on the currency and fuel domestic price 
increases. 
 
HUME