Indonesia should be wary of inflation next: RBS

Its economy may be expanding despite weakened global demand but inflationary risks abound.

Bank of Indonesia should be vigilant about these prices pressures as it continues to loosen up monetary policy to stimulate domestic activity, said RBS in a new emerging markets report.

Here's more from RBS:

Defying regional trends, Indonesia reported a pick-up in sequential growth momentum for 4Q11. The economy grew 6.5%yoy, stronger than the 6% we had forecast but in line with market expectations.

According to our estimates this translates into a seasonally adjusted expansion of 1.9%qoq, the fastest pace in four quarters. Investment was the key driver, trumping even contributions from private consumer spending.

Following this out-turn, the positive output gap – or extent by which actual output is exceeding long-term potential – is the largest we have seen since pre-Asian financial crisis.

We came close to matching the gap in Sep08 – just before the Lehman crisis – but not quite. Actual output as of 4Q11 was 1.3% above long-term potential, versus 0.9% in 3Q08 and 1.7% in 1Q98.

With the economy performing for a fifth straight quarter now above 'capacity', the key take-away here is that Bank Indonesia needs to take heed of inflationary risks as it presses ahead with monetary easing. Actual inflation readings may be unarguably benign at the moment, but the output gap is indicative of pressure on resources. Meanwhile bank lending has continued to accelerate, and inflation expectations have remained near record levels.

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