IMF Comfortable with Indonesia's Inflation Stance

(News Today) - Bank Indonesia's current monetary policy stance is appropriate given that inflation is within the target range and the risk that hiking rates now could attract more volatile portfolio capital, the International Monetary Fund said Friday.

“Looking ahead, Directors advised that Bank Indonesia should signal its readiness to respond to rising inflationary pressures to anchor inflation expectations within the 4%-6% target range,“ the IMF said in its latest assessment of Indonesia's financial system stability. The fund estimates inflation will reach 5.9% by the end of this year.

After cutting its overnight rate by a total of 300 basis points during the global downturn, Bank Indonesia has kept the rate unchanged at 6.50% since August last year to help the economy to recover while inflation eased. Inflation has gained pace in the last two months, but Bank Indonesia avoided raising its policy rate and instead sought to curb liquidity by requiring commercial banks to raise their mandatory primary reserves at the central bank from Nov. 1.

Expectations for 2011 are that inflation will be at the top end of the target range and several risk factors could push it higher, the IMF said. “Thus, unwinding monetary accommodation may need to start in the second half of 2010,“ it added.

Thomas Rumbaugh, division chief in the IMF's Asia & Pacific Department and mission chief for Indonesia, said that Bank Indonesia's move to increase the banks' reserve requirement “is a step in the right direction.“

The fund cautioned that administrative measures to fuel credit growth should be avoided since such actions could conflict with banks' prudential policies and risk management practices.

Bank Indonesia earlier this month introduced a measure to encourage commercial banks to lend. It requires commercial banks to maintain lending-to-deposit ratios between 78% and 100%.

The IMF said that while the banking system appears adequately capitalized, its stress tests showed that Indonesian banks are vulnerable to credit risk, with the mid-sized to large banks most at risk.

If there are shocks to the economy, the IMF said that the non-performing loan ratio could peak at 31.5% in the third quarter of 2011 from 3.5% currently, and capital for a number of banks could fall below the regulatory minimum level, with a few becoming insolvent. Small banks, with significant capital and liquidity buffers, would weather the stress scenarios better than large and mid-sized banks, and private banks better than the four state-owned banks. Foreign-owned banks appeared relatively resilient in the tests, although seven could become under-capitalized and one insolvent.

The IMF said that the rupiah exchange rate is broadly in equilibrium, but added that attaining the appropriate policy mix to manage volatile capital inflows is an ongoing challenge.

“In this respect, the package of measures announced on June 16 could help improve monetary operations and lower volatility of short-term capital flows,“ it said referring to the introduction of a month-month holding period for Bank Indonesia's certificates, and the introduction of longer maturities for these securities.

The IMF maintained that the Southeast Asia's largest economy will likely grow 6% this year, supported by a recovery in investment. It expects Indonesia's economic growth rise to 7% in the medium term as infrastructure development takes hold.

It added that phasing out energy subsidies is key to boosting the government's budget ability to finance infrastructure projects.

Source : kompas

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