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NEWS UPDATES Asean Affairs        29 January 2011

Inflation may harm Indonesia's central bank reputation

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After a stellar 2010, when Indonesia's economic planners had a good record, analysts now wonder whether the central bank's reluctance to hike interest rates in the face of increasing inflation could destroy their hard-won credibility.

Already this year there has been a mini-run on the stock market, bond yields have risen 200 basis points and the rupiah has dipped as concern that Bank Indonesia is behind the curve on policy has spooked the market.

Yet the governors at the vast and gleaming bank headquarters in Central Jakarta seem unmoved, content to keep the core interest rate at 6.5 percent - the same record low level it has held for more than 18 months - even as many other central banks in the region have tightened policy.

"This is a period when fund owners, especially foreigners, really want the BI rate to be raised," the central bank governor, Darmin Nausution, told a briefing of senior editors this week, flanked by his more somber deputies. "Indeed, a BI rate hike will reduce liquidity in the economy, more or less cutting consumption [and] reducing inflationary pressures - but it can also invite more capital inflows."

At the heart of the bank's caution lies the fear that the "hot money" that has poured into Indonesia and many other emerging markets in the past 18 months could just as quickly evaporate, plunging the country into chaos like that in 1998, when longtime President Suharto resigned amid massive social unrest caused by the Asian financial crisis.

But while the governors see the clamor for a rate rise as a hoped-for, self-fulfilling prophecy by outsiders, the economists making those calls are questioning the bank's credibility. "They are missing the global context," said Wellian Wiranto, a Singapore-based economist with HSBC, referring to mounting inflationary pressures around the world.

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