Contributors: Macroeconomic, Finance, and Political Economy Research Group

Introduction

As Indonesia moves through 2024, the economy is grappling with inflation and currency pressures that are affecting households and businesses alike. The Indonesia Economic Outlook Q3-2024 report sheds light on these critical issues, highlighting the challenges posed by inflation and a weakening Rupiah. Amid rising global economic uncertainty, Indonesia’s central bank, Bank Indonesia (BI), has taken active steps to manage inflation and stabilize the currency to ensure sustained economic growth.

The country’s inflation rate, while largely stable, is under pressure from factors such as fluctuating food prices, global market volatility, and supply chain disruptions. Meanwhile, the Rupiah has been experiencing depreciation against the US dollar, primarily due to global financial uncertainties and shifting policy expectations. This article explores these inflationary and currency dynamics and examines the measures in place to protect economic stability in Indonesia.

Current Inflation Trends in Indonesia

As of June 2024, Indonesia’s headline inflation rate stood at 2.51% year-over-year, a decrease from 2.84% in the previous month. This marks the third consecutive month of decline, as the effects of seasonal demand during Ramadan and Eid al-Fitr, as well as the impact of El Niño, begin to fade. The Central and Regional Inflation Control Teams (TPIP and TPID), along with the National Food Inflation Control Movement (GNPIP), have been instrumental in controlling inflation by ensuring food supply chain stability and enhancing production efficiencies.

In terms of inflation components:

• Administered Prices: This category, which includes items whose prices are regulated by the government, rose to 1.68% year-over-year in June, up from 1.52% in May. Key drivers were an increase in airfares during the Eid al-Adha holiday and higher prices for machine-made kretek cigarettes, where producers have passed on the impact of rising excise duties to consumers.
• Core Inflation: Reflecting underlying inflationary pressures without the volatile items, core inflation slightly declined to 1.90% in June from 1.93% in May, indicating that inflation expectations are relatively well-anchored.
• Volatile Prices: Volatile items, primarily food-related, saw inflation fall to 5.96% from 8.14% month-over-month, as the supply of foodstuffs like rice and chicken stabilized.

Although inflation remains within BI’s target range of 1.5% to 3.5%, Indonesia is not immune to external inflationary pressures, particularly those linked to global commodity markets and import costs. Effective policy responses are crucial to keep inflation under control and protect the purchasing power of households.

The Decline of the Rupiah and Its Impact

The Rupiah has been under pressure in 2024, with the currency depreciating by 6.33% year-to-date as of June. This decline is attributed to various factors:

• Global Uncertainties and Fed Policy: The Federal Reserve’s shifting interest rate policies have influenced capital flows, leading investors to move away from emerging market currencies, including the Rupiah.
• Domestic Policy Uncertainty: Indonesia’s political transition following the recent elections has led to a degree of caution among investors, further contributing to capital outflows.

The weakening Rupiah has a twofold impact on the economy. On one hand, it makes Indonesian exports more competitive, potentially increasing demand for goods in sectors like manufacturing, mining, and agriculture. On the other hand, it raises the cost of imports, which can contribute to inflationary pressures, particularly for essential goods and raw materials that the country relies on from abroad. Imported inflation poses a challenge, as a depreciating currency often leads to higher domestic prices for goods, impacting household spending and business costs.

Sectoral Implications of Rising Inflation and Currency Depreciation

The inflationary environment and currency depreciation impact various sectors differently:

1. Agriculture and Food: Inflation in food items, especially staples like rice, directly affects household budgets. A weaker Rupiah increases the cost of imported agricultural inputs, such as fertilizer, potentially raising domestic food prices.
2. Manufacturing and Industrial Production: While currency depreciation could benefit export-oriented manufacturers by making Indonesian goods cheaper globally, it increases production costs for industries reliant on imported materials. The manufacturing sector’s competitiveness may suffer if it cannot fully pass on these costs to consumers.
3. Consumer Goods: As household purchasing power weakens, demand for discretionary consumer goods may decline. This sector is particularly sensitive to inflation as consumers adjust their budgets, focusing more on essentials than non-essentials.
4. Tourism and Hospitality: A weaker Rupiah may benefit tourism by making Indonesia a more affordable destination for international visitors. However, inflationary pressures may reduce domestic spending in these sectors.

Inflation Management and Monetary Policy Responses

Bank Indonesia has adopted a mix of monetary policy tools and cooperative strategies to manage inflationary pressures and stabilize the Rupiah. BI’s approach includes maintaining price stability, fostering economic resilience, and improving coordination between the government and the central bank. Key measures include:

1. Interest Rate Adjustments: BI’s policy rate has remained steady, with careful monitoring to balance inflation control with economic growth support. Adjusting interest rates is a primary tool for curbing inflation and managing currency fluctuations. However, BI has signaled that it will adjust rates as necessary to contain inflation within the target range.
2. Liquidity Management: To support domestic liquidity, Bank Indonesia has implemented the Macroprudential Liquidity Incentive Policy (KLM), which bolsters banking liquidity and strengthens the capital base, enabling banks to meet credit demand without exerting additional inflationary pressures.
3. Coordinated Inflation Control Efforts: BI collaborates with the TPIP and TPID on food supply chains, implementing the National Food Inflation Control Movement (GNPIP) to boost food production, improve supply chain efficiency, and stabilize prices. These efforts have successfully contained food inflation despite global and local disruptions.
4. Stabilizing Currency through Foreign Reserves: BI has intervened in the currency market using its foreign exchange reserves to manage the Rupiah’s volatility. This intervention aims to stabilize the exchange rate, preventing excessive depreciation and curbing imported inflation. The coordinated approach of BI, TPIP, and TPID has so far proven effective in limiting inflation’s impact on consumers.

Potential Risks and Challenges Ahead

Despite BI’s robust efforts, certain risks could pose challenges in maintaining economic stability:

1. Fluctuating Food Supply: The volatility of food prices remains a concern. BPS (Badan Pusat Statistik) projects a 40-50% drop in rice production from June to October 2024 compared to April-May. This reduction in output could lead to a spike in rice prices, a staple in the Indonesian diet, affecting household budgets and potentially fueling inflation.
2. Global Market Instability: Ongoing global economic uncertainties, including energy price fluctuations, geopolitical tensions, and trade policy shifts, could impact Indonesia’s trade balance and capital flows, further pressuring the Rupiah.
3. Imported Inflation Risks: The depreciating Rupiah increases the cost of imported goods, adding inflationary pressure to domestic prices. Key imports such as fuel, machinery, and raw materials are particularly susceptible to price hikes, and BI must balance currency stability with its other policy objectives.
4. Dependency on Seasonal Demand: The Indonesian economy has shown a reliance on seasonal factors, such as Ramadan and Eid festivities, which create temporary surges in consumption and economic activity. However, these drivers are not sustainable, and long-term strategies to diversify growth will be crucial to offset inflationary pressures.

Outlook and Strategic Priorities for Economic Stability

Indonesia’s inflation and currency challenges underscore the importance of ongoing coordination between Bank Indonesia, the government, and the private sector to support sustainable economic growth. The outlook for the rest of 2024 depends on BI’s ability to maintain inflation within the target range, stabilize the Rupiah, and mitigate external pressures.

Recommendations for Continued Stability:

1. Diversify Domestic Production: To reduce dependency on imports and mitigate imported inflation, Indonesia should focus on developing local industries, particularly in agriculture and manufacturing. This will enhance self-sufficiency and reduce vulnerability to global price shifts.
2. Promote Food Security Initiatives: Strengthening food security policies, such as expanding domestic food production and ensuring stable supplies of essential items, can protect households from food inflation. Investing in agricultural productivity and supporting local farmers can help stabilize food prices.
3. Strengthen Economic Resilience Through Fiscal Policy: Strategic fiscal measures, such as targeted subsidies and social assistance programs, can help households cope with inflation. Temporary subsidies for essential goods may provide relief to vulnerable populations, while infrastructure investments can boost long-term productivity.

Conclusion

Inflation and currency stability remain pressing concerns for Indonesia in 2024. Through coordinated efforts, Bank Indonesia and the government have managed to contain inflation within target levels and provide stability amid external pressures. However, the sustained depreciation of the Rupiah highlights Indonesia’s sensitivity to global economic trends and the need for proactive policy measures to ensure resilience.

As Indonesia navigates these challenges, strategic investments in domestic production, food security, and inflation control will be key to maintaining stability and protecting households from economic shocks. The findings in the Indonesia Economic Outlook Q3-2024 highlight the importance of continued vigilance and coordinated action to foster a stable economic environment for all Indonesians.

Acknowledgment: This article is based on insights from the Indonesia Economic Outlook Q3-2024 report by the Macroeconomic, Finance, and Political Economy Research Group. Special thanks to Jahen F. Rezki, Ph.D., Teuku Riefky, Faradina Alifia Maizar, Muhammad Adriansyah, and Difa Fitriani for their invaluable contributions to understanding Indonesia