Bank Indonesia Walks Down Middle Path To Balance Inflation, Growth

Jakarta. The central bank kept its benchmark interest rate unchanged on Friday, but ordered banks to set aside more cash reserves after inflation accelerated to a 16-month high in August.

Lenders will be required to set aside 8 percent of their deposits as primary reserves, up from 5 percent, a move that may absorb Rp 50 trillion ($5.6 billion) of excess liquidity, Bank Indonesia said. Governor Darmin Nasution and his colleagues held the benchmark interest rate at a record-low 6.5 percent.

“Considering the potential for future inflationary pressures, the Bank Indonesia board of governors felt it was important to raise the primary reserve requirement,” Darmin said.

The move follows five-straight months of quickening gains in consumer prices that have highlighted the risks of Indonesia refraining from following its counterparts across Asia in raising interest rates.

President Susilo Bambang Yudhoyono has focused on bolstering growth, targeting an average 6.6 percent annual expansion rate through the end of his term in 2014.

“The bank is worried that excess funds held by commercial banks will eventually feed through into further rises in inflation,” said Robert Prior-Wandesforde, an economist at Credit Suisse Group in Singapore. “Bank Indonesia will probably now want to wait and see how the banks react before deciding when and whether to hike the policy rate.”

Indonesia’s inflation rose to 6.44 percent in August, a 16-month high, amid Ramadan and ahead of the Idul Fitri holiday marking the end of the fasting month. Higher electricity costs after a government-approved rate hike in July also added to inflationary pressures.

Darmin has said the full-year inflation rate may exceed the targeted range of 4 percent to 6 percent, but has also indicated that inflationary pressures were likely to ease after the holiday period ends this month.

The increase in banks’ reserve requirement may give Bank Indonesia room to delay rate increases as global growth slows, said Enrico Tanuwidjaja, an economist at OSK-DMG Group in Singapore.

“Bank Indonesia doesn’t believe inflationary pressures will be elevated forever and doesn’t want to take the drastic step of raising interest rates,” Enrico said. “If the global recovery is gradual, we may see a rate hike postponed to the latter half of 2011.”

The new primary reserve level will take effect on Nov. 1, and beginning in March, the central bank will link a bank’s reserve requirement to how much of its funds a lender gives out in loans. It will impose a penalty for banks whose loan-to-deposit ratio is below 78 percent or more than 100 percent.

The regulation is aimed at getting a number of large banks with a wider deposit base to lend out more, said Wellian Wiranto, a Singapore-based economist at HSBC Holdings.

“All banks will get the ‘stick’ of having to deposit more cash in the form of the primary reserve requirement ratio starting from Nov. 1,” Wellian said.

“This would help to tighten liquidity in the immediate period. However, fast forward to March 2011, and banks which are able to keep their loan-to- deposit ratios within the prescribed window will enjoy the ‘carrot’ of having to put up less reserve requirement.”

The central bank kept the secondary reserve requirement, comprising a combination of government bonds and Bank Indonesia certificates, at 2.5 percent. The bank uses the two measures for how much commercial lenders need to place in deposits at the central bank to manage liquidity in the banking system.