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Why Indonesia's current account deficits are bittersweet

Part 3
Why Indonesia's current account deficits are bittersweet (Part 3 of 5)

Hawkish rates action in Indonesia aims to shield the economy

Indonesia’s rates hike

Bank Indonesia surprised investors earlier this month with an additional 50 basis point hike. The rates hike followed another 50 basis point hike from an unscheduled meeting on August 29 and yet another 25 basis point hike in the previous meeting.

The combined 1.25% increase in rates sends a strong message to market participants that Indonesia is ready to take a hawkish (aggressive) stance against inflation, which spiked out of control over the past two months.

Indonesia InflationEnlarge Graph

Inflation is expected to minimally increase month over month. However, the year-end 2013 inflation is expected to be between 9% and 9.8%. Such high inflation erodes real returns for investors. So while inflation may slow down, it remains elevated.

Change of stance in government policy

The recent actions highlight that the government is ready to sacrifice growth in order to rein in inflation. Economists didn’t expect the extremely hawkish attitude. As clarification, a monetary policy action is considered hawkish when it advocates for higher rates to curve inflation despite sacrificing growth. A dovish action is the opposite, advocating for lower rates to fuel inflation despite inflation risks. Bernanke’s actions were considered dovish given the extended period of low rates, even though inflation wasn’t a relevant issue during his time.

Despite the tough stance against inflation, which may sacrifice growth, the actions were likely crucial and required. A country can’t grow much when inflation is an issue since it drives away investors. A great example is Brazil (EWZ), whose growth was slowed down by inflation. Plus, the actions will help stop the fast depreciation of the Indonesian rupiah, though Bank Indonesia did acknowledge that a weaker currency would be beneficial and necessary in order to boost exports.

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