High interest rates in the business environment have had several impacts on the economy, namely, hampering business operations and credit creation as well as hindering investment. — The Jakarta Post
JAKARTA: Over the past few years, many countries have struggled to reduce high inflation rates as the economic recovery post-pandemic was followed by a surge in inflation rates around the world.
And the situation got worse with the eruption of the Russia-Ukraine war.
In the United States, the annual inflation rate in June 2022 was 9.1%, the highest level in the last 20 years.
A similar thing also happened in the eurozone, where annual inflation reached 10.6% at the end of 2022, which is also the highest level in the last 20 years.
As a result, central banks, including the US Federal Reserve (Fed), the European Central Bank and the Bank of England, have struggled to reduce inflation by raising policy rates.
The Fed has aggressively raised interest rates by 525 basis points (bps) since the end of 2022, from 0.25% to the current 5.5%. The ECB also tracked a similar policy, implementing an aggressive interest rate increase of 450 bps in less than a year.
As a result, the high interest rates in the business environment have had several impacts on the economy, namely hampering business operations and credit creation as well as hindering investment.
This situation has limited economic activities and ultimately poses the threat of a potential economic slowdown in 2023, which could continue until the new year.
The International Monetary Fund’s projection showed that the global economy in 2022 grew by 3.5%, while in 2023 it is expected to only grow by 3%.
A phenomenon called an inverted yield curve also emerged as an unfavourable condition in which long-tenor bond interest rates have lower yields than short-tenor bonds, indicating that investors were considering various risks, including the possibility of a recession.
Yet, despite various threats of slowdown, the economy in the United States is somehow still growing quite strongly, mainly driven by strong household consumption.
The United States labour market remains tight, creating upward pressure on wages. The US inflation rate has come down to 3.7% but is still considered high and unsustainable.
Fed chairman Jerome Powell’s latest comment said a solid US economy can still put pressure on inflation. Moreover, the upcoming release of US gross domestic product growth for the third quarter of 2023 (3Q23) is estimated to show 4.3% year-on-year (y-o-y) growth, faster than the realisation of 2.1% y-o-y in 2Q23.
Those factors have encouraged the possibility of higher and longer interest rates, making them one of the most closely watched issues in global markets.
Meanwhile, in Indonesia, post-Covid economic activity did not necessarily increase the inflation rate at a sudden pace. When the government gradually dropped public activity restrictions, starting in July 2021, the domestic inflation rate remained stable at around 1% to 2% on an annual basis and was successfully maintained until early 2022.
Yet at the beginning of 2022, the geopolitical conflict in one of the world’s largest crude oil producers, Ukraine, caused a sharp rise in world commodity prices, including coal and crude oil.
At that time, Indonesia benefitted from the sharp rise in exported commodity prices such as coal and crude palm oil, which led to a large surplus in the trade balance.
However, Indonesia was also negatively impacted as the rise in crude oil prices created inflation pressures. As the world price of crude oil touched US$97.7 per barrel in August, the government finally decided to increase the price of several refined fuel oils, one of which was pertalite.
The increase in the pertalite price, which is the most widely used fuel by Indonesian households, ultimately caused domestic inflation to escalate.
In September last year, Indonesian inflation was recorded at 5.95% y-o-y, significantly higher than 1.60% y-o-y in 2021.
Fast forward to October this year, and we are faced with global conditions that are somewhat similar to the situation in September 2022.
In the midst of the global economy preparing for a potential “higher for longer” interest rate and a risk of a global economic slowdown, a war broke out between Israel and Hamas in the Middle East.
The military tensions have sparked attention from various parties, creating volatility in global markets.
Inflationary risks have reemerged as oil prices climbed to as high as US$92.6 per barrel in September 2023, further threatening domestic inflation, which is currently at a low level within Bank Indonesia’s target of 3% plus or minus 1% in 2023. — The Jakarta Post/ANN
