Bank Indonesia (BI), Indonesia's central bank, raised its benchmark interest rate by 50 basis points to 6.50 percent on Thursday for a second consecutive month rise to tackle accelerating inflation, devaluating rupiah and falling foreign exchange reserves.
The first Asian central bank to hike its benchmark rate since 2011, the BI also increased its fasbi rate, or the yield it pays to commercial banks on funds deposited at BI, by 50 basis points to 4.75 percent.
"The policy was adopted to ensure that inflation will return to its target path after the fuel price hike and the central bank will continue to maintain stability of rupiah exchange rates by providing adequate liquidity," the BI said in a statement released Thursday.
The move came after the central bank increased its benchmark rate and fasbi rate by 25 basis points respectively in mid-June to cope with expected inflation and support the weakening local currency.
Indonesia's inflation accelerated to 5.90 percent last month from a year earlier, compared with 5.47 percent in May, after the government hiked subsidized fuel prices on 22 June by an average of 33 percent. The BI expects the rate of inflation to climb to 7. 5 percent in July and 7.2 percent at the end of this year.
Indonesia's currency rupiah is one of the worst performing currencies in Asia, which has lost 3 percent so far this year to its lowest level since July 2009 against the U.S. dollar, according to BI's data.
The data also showed the country's foreign exchange reserve dropped to 98.1 billion U.S. dollars as a result of the intervention by BI, which rely on foreign capital to fund current account deficits to defend the weakening currency over the past several months.
Eric Sugandi, an economist with Standard Chartered Indonesia, told Xinhua that inflation in the following months will face heavy pressure as the government raised the electricity tariff from July 1 following the hike of fuel price.
"The arrival of fasting month and the start of the new school year will also drive up household goods and food prices," Eric said.
Indonesia, which has the world's largest Muslim population, started to observe the fasting month of Ramadan on Wednesday, which could add to inflation pressure as most people consume more extensively in the evening and early morning.
Eric said high inflation will hit both Indonesia's household consumption and investment, adding that the BI need to safeguard the country's economy by hiking the benchmark rate.
"If BI doesn't hike the rate, the inflation can soar to 9 percent," Eric said, adding that BI's move will help ease investor 's concern on inflation and show its readiness to defend rupiah.
The economist also said the benchmark rate hike would somehow bring head wind to the country's GDP growth, which has eased to 6 percent in the first quarter, the slowest in two years. The BI expected the country's economy to expand by 5.8 percent to 6.2 percent in 2013, lower than its earlier forecast of 6.2 percent to 6.6 percent.
"Indonesia's economy is facing more uncertainties because of the balance of payments deterioration, high inflation, falling commodity prices and policy uncertainty ahead of national elections next year," Eric said.