Inflation Surges in Indonesia after Government Reduced Fuel Subsidies

Inflation in Indonesia rose almost 18% in October largely as a result of government action on October 1, reducing subsidies on petroleum related products. Kerosene prices, for example, almost tripled and diesel prices doubled. The hardest hit components of the consumer price index were transportation and communication, showing a year-over-year rise of almost 45% and foodstuffs, 18%. The first chart shows the year-over-year change in the total index and in the transportation and communication component.

A major reason for the government's action in reducing the subsidies was the growing cost and its impact on the budget balance. In the first nine months of this year expenditures were about 20% above those of the corresponding period of last year. This increase follows one of 16.2% for all of 2004 and 14.5% for 2002 and only 1.3% for 2001.

Following the announcement of the spike in inflation, the Central Bank raised the one month bill rate 125 basis points from 11% to 12.25%. The real base interest rate (nominal value less the rate of inflation) is shown in the second chart. The real rate has declined substantially over the past five years, from 12% in 2000 to zero or slightly negative values in several recent months. The October real rate is almost -7% in spite of the hefty rise in the nominal rate.