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The recent easing of consumer price inflation has improved
Indonesia's near-term inflation outlook. However, whether this is part
of a long-term trend, or just a trough, remains a question yet to be
answered.
In the longer term, inflation remains subject to risks emanating from
potential exchange rate volatility, increasing economic activity and
policy changes regarding controlled prices.
Last week, the statistics agency released its inflation figures for
October -- exactly one year after last year's doubling of fuel prices.
The inflation rate, measured on a year-on-year basis, dropped
dramatically from 14.5 percent to slightly above six percent, according
to the statistics agency. Economists were quick to revise their
year-end inflation forecasts downward. Meanwhile, the bond market
celebrated with a decline in yields for nearly all maturities. Bond
prices move inversely to yields.
The consumer-price inflation rate is a closely watched economic
indicator. It is widely used both as a benchmark for expected returns
on savings and investments, and for setting wages and pricing
contracts. The recent decline in the inflation rate has left many
wondering what lies ahead with regard to Indonesian consumer prices?
Few argue that in the near term, i.e., one year ahead, inflation is
likely to remain benign compared to historical standards. Economic
activity has not fully recovered following last year's crippling fuel
price hikes; furthermore, a stable exchange rate is leading to stable
prices for imports, thus leading to lower inflation in the near term.
However, it is not clear whether a similar outlook applies over the
longer term. Compared to other diversified economies in ASEAN
(Association of Southeast Asian Nations), Indonesia has in the past
decade experienced the highest inflation rates.
Some argue that with free trade underway and the economy becoming more
open, inflation in Indonesia may eventually head towards the levels
found in comparable neighboring economies, such as Malaysia and
Thailand, where single digit inflation has been the norm over the last
couple of decades.
But then again, the benefits of openness and liberalization in
Indonesia, in terms of inflation, have not been so obvious. Of course,
imports from cost-competitive countries, such as China, have relieved
the strain on many households as regards their purchases of toys,
electrical appliances and even motor vehicles. But despite more
openness and intensifying trade with China, inflation in the long term
does not appear to be easing.
In the 10-year period prior to the financial crisis of 1997, annual
inflation rates averaged slightly over eight percent. However, over the
last six years, inflation averaged slightly more than 10 percent!
What's also interesting to note is that consumer-price inflation has
been at least twice as volatile in the latter period compared to the
former.
Part of this increased volatility may be attributed to Indonesia's
free-floating exchange-rate regime, whereas prior to the crisis the
exchange rate was maintained by the central bank under a managed float.
It is interesting to note that in the first half of the year, the
rupiah-dollar exchange rate was about twice as volatile as the Thai
baht and Philippines peso rates. These fluctuations affect inflation
through the prices of imported goods and materials.
So next year, much depends on whether Indonesia's commodity-driven
trade surplus and strong capital inflows to the financial markets will
continue to support the exchange rate. With imports tending to rise as
economic activity strengthens, and with the interest rate differential
with the US narrowing, no definite answer is currently discernible.
Another part of the volatility in inflation can be explained by the
easing of various price subsidies in the economy. The government has
raised fuel prices 10 times over the past decade. Yet over the last
five years, spending on direct subsidies still averaged the equivalent
of nearly five percent of the economy (Malaysia, by comparison, spends
less than half of that on subsidies). Most of this spending has been
used to keep the prices of various commodities, especially fuel,
artificially low.
Currently, kerosene is still heavily subsidized and sells at half the
non-subsidized price paid by industry. Kerosene subsidies make up the
bulk of the government's fuel subsidies. However, the government also
pays a subvention to state power utility PLN to keep electricity prices
low. The sums involved in calculating this subvention have recently
been the subject of a heated debate.
As the economy continues to become more open and heads further towards
liberalization, these price subsidies may be further reduced over time.
How all this will affect inflation remains to be seen.
In the meantime, let us just enjoy this period of stability. while it
lasts.
The
writer is an economist at Bahana Securities.
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