By Fransiska Nangoy and Bernadette Christina
(Reuters) -Bank Indonesia (BI) Governor Perry Warjiyo said the central bank does not expect inflation to top 3% until 2023, but the central bank would start communicating possible changes to its policy rates ahead of time to avoid any market shocks.
With the economic outlook brightening, the Indonesian central bank plans to start reducing liquidity in the banking system next year, rolling back loose monetary policy used to weather the pandemic, although it is closely monitoring the spread of the Omicron variant of the coronavirus.
BI has injected more than 860 trillion rupiah ($59.74 billion) of liquidity into the financial system since last year, including through direct purchases of government bonds, and slashed key rates by 150 basis points to help cushion the economic hit from the health crisis and anti-virus measures.
Unlike the case in many other economies which are recovering from the pandemic slump, price pressures in Indonesia remain mild, but they are creeping up. The consumer inflation rate in November rose to 1.75%, a 17-month high.
Warjiyo reiterated that BI will keep the main policy rate at a record low 3.50% until inflation shows signs of accelerating.
"Our current projection is inflation starting (to rise) above 3% and moving up towards 4% sometimes in second quarter or early third quarter 2023," he said in an interview during a Reuters Next conference.
"But by nature, interest rate decisions need to be forward looking, needs to be preemptive, need to be front loading," he added.
Some analysts believe BI will need to start considering rate hikes from mid-2022 as global supply chain disruptions and high commodity prices had already started affecting production costs.
BI's target inflation next year is between 2% and 4%.
Next year BI will mop up liquidity and will start signaling toward the end of the year further policy direction, depending on trends in inflation and growth, Warjiyo said.
Bank Indonesia will communicate with markets the liquidity reduction plan ahead of time, he said, adding that the central bank will make sure the move will not compromise banks' ability lend or purchase government bonds.
Tools which BI could use to absorb liquidity include raising banks' reserve requirements, Warjiyo added.
Meanwhile, he said BI is monitoring how the spread of the new COVID-19 variant will affect the normalisation of fiscal and monetary policy in the developed world.
"This is important because those normalisations will impact our ability to grow as well as ensure our external stability," he said.
Indonesia will make sure that yield differential between rupiah assets and U.S. Treasury yields will remain attractive for investors to avoid massive outflows as the Federal Reserve is expected to start raising rates next year.
Warjiyo said on Friday the central bank will not hesitate to "come to the market" to stabilise the rupiah if needed.
But he said the country is in much better condition to weather any rupiah volatility than in the past, when Fed policy tightening triggered heavy outflows from emerging markets.
($1 = 14,395 rupiah)