BI has little room to keep benchmark rate, observers say

Inflationary pressure from the government subsidized fuel ban and rising commodity prices will
force Bank Indonesia (BI) to increase its benchmark interest rate in 2011, researchers say.

Economic researchers at the Indonesian Institute of Sciences (LIPI) estimated that the central
bank could begin raising interest rates in the second quarter of next year to keep inflation in
check.

Speaking during a briefing on the economic outlook for 2011, Wednesday, Wijaya Adi, a
researcher at LIPI’s Center of Economic Research, said that the current, record-low BI rate of 6.5
percent could not be maintained next year due to stronger inflationary pressure.

He said that the central bank would likely increase the benchmark rate by 25 basis points to 6.75
percent at the beginning of the second quarter to curb increasing inflation resulting from the
restriction of the subsidized fuel sales.

The government will prohibit private cars from using subsidized fuel beginning April in Greater
Jakarta and in July in Java and Bali.

The restriction will be implemented in Sumatra and Kalimantan in 2012 and in Sulawesi and
other areas in 2013.

The National Statistics Agency (BPS) has estimated that the subsidized fuel sales restriction in
Greater Jakarta alone could cause inflation to increase by 0.15 percent.

With private car owners paying higher prices for gasoline, combined with the rise in
commodities prices, inflationary pressure will become stronger in the third quarter, LIPI
economist Latif Adam said at the event.

He added that as a consequence of the stronger inflationary pressure, the central bank would
have to further increase the rate by another 25 basis points in the third quarter to 7 percent.

“If inflation goes out of control, BI will need to hike the rate. And when that happens, lending
rates will also increase. With the current, relatively high, lending rate, you can imagine how
expensive it will be to borrow money,” Wijaya told a press briefing at the LIPI offices in Jakarta.

Wijaya and Latif agreed that a higher BI rate would result in an increase in lending rates charged
by commercial banks, which would make loans more expensive for borrowers, which would in
turn lower lending growth, they said.

BI has set a 24 percent loan growth target for 2012 despite the lower-than-expected growth this
year.

According to BI data released on Wednesday, outstanding loans reached Rp 1,708.15 trillion

(US$189.6 billion) as of Dec. 17, 22.76 percent higher compared to the same period last year.
Throughout the year, lending grew by 19.43 percent, below the central bank’s 22 percent growth
target.

As part of its pro-growth policy, the central bank has kept its benchmark rate at 6.5 percent for
16 months to ensure banks would not hike already-high lending rates. Instead, the central bank
has used its non-interest rate mechanisms, such as raising minimum reserves requirements, to
keep the inflation in track.

The average basic lending rate reached 11.97 percent by Dec. 15, sliding by 0.97 basis points
compared to the same period last year. Lending rates have slid 0.86 basis points so far this year,
as BI has maintained the record-low benchmark 6.5 percent interest rate for over a year.

BI has also announced several new regulations to help keep lending rates low, specifically
targeting the loan-to-deposit ratio (LDR) and prime lending rate, which are expected to be in
effect in the first quarter of next year.

The LDR regulation will require banks to store a higher minimum reserve (GWM) if they have
LDRs outside a range of 78 percent to 100 percent, which was expected to encourage banks to
lend more. Meanwhile, the prime lending rate regulation will require banks to announce their
lending rate components, which is expected to increase competition in the banking industry and
eventually lower lending rates.

Wijaya said the higher inflationary pressures in the second quarter would force the central bank
to further increase its benchmark rate to 7 percent in July.

“Speculation in the global oil market will spur prices to peak in 2011 therefore domestic oil
prices will also rise as we import oil,” he added.

Wijaya said that with the higher rate, Indonesia’s debt markets would be even more attractive to
foreign investors.

Foreign investors have pumped Rp 117.24 trillion in funds in 2010 so far, as of Dec. 17,
controlling about 60 percent of local stocks and 30 percent of government bonds and BI
certificates, respectively, according to BI and Indonesian Central Securities Depository data.
(est).