The overriding objectives of ITF and Flexible ITF are the same, namely to control inflation. Notwithstanding, a nascent dimension that emerged from the Global Financial Crisis was the central bank's integrated role in maintaining financial system stability, while achieving the price stability mandate. The embodiment of Flexible ITF is the flexibility to integrate monetary and financial system stability through a policy mix of monetary, macroprudential, exchange rate and capital flow instruments, while strengthening the institutional arrangements to optimise the role of policy coordination and communication.
In accordance with the inflation targeting strategy, Bank Indonesia announces the inflation target for a specific future period. The inflation target is set by the Government in coordination with Bank Indonesia for the upcoming three years through a Minister of Finance Regulation (PMK). Bank Indonesia regularly evaluates whether the inflation projections remain in line with the target corridor set. The projections are based on several models and the various information available that depict inflation conditions moving forward as the basis for the monetary policies instituted. This is due to the implications of the time lag effect of monetary policy, with the monetary policy target thus based on future inflation projections. Efforts to achieve the target are implemented through a policy mix response based on transparency and accountability.
Seeking to strengthen the effectiveness of monetary policy transmission, Bank Indonesia set the BI 7-Day (Reverse) Repo Rate (BI7DRR) as the policy rate on 19th August 2016, representing the monetary policy response signal in terms of controlling inflation in line with the target corridor. Use of BI7DRR as the reference rate is part of the monetary policy reformulation performed by Bank Indonesia.
Previously, Bank Indonesia used the BI Rate as the reference rate, equivalent to a 12-month monetary instrument. Through BI7DRR as the reference rate, however, the tenor of the monetary instrument was shortened to 7 days, which is expected to accelerate monetary policy transmission and steer inflation towards the target corridor.
There were three main objectives of the monetary policy reformulation. First, strengthening the signal of monetary policy direction. Second, strengthening monetary policy transmission effectiveness through its impact on interest rate movements in the money market and banking industry. Third, accelerating financial market deepening, particularly in terms of transactions and formation of the interest rate structure in the interbank money market for tenors of 3-12 months.
In practice, monetary policy reformulation upholds four salient principles. First, reformulation does not change the monetary policy framework as Bank Indonesia continues to apply flexible ITF. Second, reformulation does not change the current monetary policy stance. Third, reformulation ensures the policy rate is reflected in monetary instruments and is transactable with Bank Indonesia. Fourth, determination of the operational target based on various considerations can be influenced by the policy rate. Consistent with the second principle, reformulation does not change the current monetary policy stance because both the BI Rate and BI7DRR are part of the same term structure with regards to steering inflation towards the respective target.
The various aforementioned policies were strengthened through policy coordination with the Government, particularly on the supply side. Government policy is predominantly oriented towards maintaining affordable prices, uninterrupted supply and distribution as well as effective communication in order to stabilise food prices and control inflation. Policy coordination between Bank Indonesia and the Government to control inflation has been strengthened through the establishment of central and regional Inflation Control Teams (TPI). In addition, policy coordination with the Government also reinforces financial system stability. Through the Financial System Stability Committee, Bank Indonesia in conjunction with the Ministry of Finance, Indonesia Financial Services Authority (OJK) and Indonesia Deposit Insurance Corporation (IDIC) determine which coordination measures are necessary and provide recommendations in terms of monitoring and maintaining financial system stability.