(Adds more comments from economists, details on markets)
By Aditya Suharmoko
JAKARTA, Oct 3 (Reuters) - Indonesia’s inflation slowed in September as food prices eased after the Muslim festive season, but policymakers are walking a tightrope as they try to balance their desire to cut interest rates against pressures to stabilise financial markets.
Complicating the policy outlook in Southeast Asia’s biggest economy is the risk of higher food inflation from next year when Indonesia and other rice importers face a rise in prices from Thailand, the world’s biggest rice exporter, following a new Thai rice-price guarantee scheme imposed this month.
Annual inflation in September was 4.61 percent, below 4.79 percent in August and less than the 4.80 percent expected by most economists surveyed by Reuters, data from the country’s statistics bureau showed on Monday, cementing expectations that the central bank will hold the benchmark interest rate steady next week amid global uncertainty.
Thailand is also expected to keep interest rates on hold this month after data on Monday showed annual inflation down marginally at 4.03 percent in September, while the core rate rose to 2.92 percent, near the top of the central bank’s target range.
Indonesia is enjoying an economic boom, with growth of 6.5 percent, rising consumer spending, swelling incomes and a newly minted status as a middle-income country, with per capita GDP passing $3,000 this year.
But sustaining that, and keeping inflation in check, looks increasingly difficult in the face of volatile global markets. More than a year of heavy foreign buying of stocks and bonds has made Indonesia vulnerable to outflows that have accelerated in recent weeks as those investors pull their money out.
“We doubt that the central bank will react much to this latest inflation read, especially at times when the market still looks somewhat unstable,” said Gundy Cahyadi, an economist at OCBC Bank in Singapore.
The statistics bureau said that despite slower overall inflation, some prices were still high, such as the cost of red chilli, a favourite spice, along with gold jewellery and cigarettes due to a government plan to raise tobacco taxes.
Core inflation -- which excludes administered prices and volatile foods -- eased to 4.93 percent from 5.15 percent a month earlier, near the 5 percent level a central bank official said could trigger policy tightening. That was largely in line with the 4.96 percent expected on average by economists.
However, volatile global conditions have shifted Bank Indonesia’s stance from fighting inflation to boosting growth, and officials have indicated they might consider cutting rates.
The next central bank meeting on rates is on Oct. 11.
The main concern now for Bank Indonesia and other emerging-market central banks is to support growth, as the global economy founders, while staunching outflows of global capital that have shed nearly 5 percent from the rupiah currency since Aug 31. On Monday alone, the rupiah lost 1.7 percent.
While headline inflation could be “well below” 5 percent by year end, according to comments on Monday by statistics bureau chief Rusman Heriawan, the weak currency adds to a host of underlying inflationary pressures -- from retail sales growth to bank credit and already-strong import growth.
Bank Indonesia last month left its benchmark policy rate steady at 6.75 percent for a seventh straight month but lowered the floor on interbank overnight rates, seen by some as a form of policy easing.
Its hands are tied from doing much more, say economists. It is widely expected to keep the rate steady for the rest of this year to try to make government bonds more attractive while investors fret over riskier assets.
“It is difficult to increase the rate as (core) inflation eased to 4.93 percent,” said Fauzi Ichsan, an economist at Standard Chartered in Jakarta. “In normal conditions, Bank Indonesia could plan on raising the rate. But now, conditions are not normal.”
That’s left Indonesian policymakers with little choice but to pursue seldom-used measures in recent weeks -- from buying back bonds to telling state insurers and banks not to sell government bonds in an attempt to stabilise prices.
“Pension funds and insurance firms are not too dominant. What is determining the market is foreign investment, and only the government that can balance that,” said Destry Damayanti, an economist at state Bank Mandiri, Indonesia’s largest bank by assets.
Foreign investors now dominate the Indonesian bond market. Their ownership stood at 218.53 trillion rupiah ($24.9 billion), or 31.4 percent of total outstanding bonds, as of Sept. 29, down from a record 251.23 trillion rupiah, or 35.7 percent, on Sept. 9, according to data from the finance ministry.
Indonesia made similar efforts three years ago to protect its bond and currency markets as Wall Street giant Lehman Brothers collapsed. Emerging market authorities now have redoubled efforts.
The tactics are working on some fronts, pushing up government bond prices, for instance. The yield on benchmark 10-year Indonesian government bond has dropped by about 30 basis points in the past week to about 6.9 percent, as prices climbed, due to heavy government intervention.
“Their intentions to stabilise the markets have been echoed by very strong actions,” said Teck Wee Yeo, an analyst at RBS in Singapore. “It has been effective to a certain extent.”
Bambang Brodjonegoro, fiscal policy chief at the finance ministry, said the ministry had asked state firms to prepare funds to buy back bonds if needed, under a scheme dubbed bond stabilisation fund, to shore up the bond market.
Indonesia’s capital market regulator has also advised state firms not to panic and sell stocks following volatility in Jakarta’s benchmark stock index in recent days due to foreign capital outflows.
“This is certainly good and proactive move, in our view,” said Radhika Rao, an analyst at Forecast in Singapore. “Think more moral suasion efforts are likely, though authorities are unlikely to use draconian controls.”
But sentiment is fragile. Jakarta stocks fell as much as five percent on Monday. The central bank sees the Indonesian economy expanding 6.6 percent this year, but there are risks further out. The bank’s governor said in early September the GDP rise next year could be lower than a 6.7 percent government target due to global uncertainty.
“Better-than-expected inflation figures are positive but global investors are still concerned with conditions in their home markets,” said Mandiri’s Damayanti. ($1 = 8,790 rupiah) (Additional reporting by Adriana Nina Kusuma. Editing by Jason Szep)