UPDATE 1-Indonesia faces economic pain from fuel price hike
* Inflation in 2013 seen hitting 5-year high
* Will put pressure on central bank to raise rates
* Higher cost of living to sap consumption growth
* Stocks rise on the day, but rupiah under pressure
(Recasts, adds finmin quotes, analysts, context)
JAKARTA, June 18 (Reuters) - Indonesia's planned hike in fuel prices will drive 2013 inflation to a five-year high and pressure the central bank to raise interest rates again even as the increased cost of living weighs on consumers in Southeast Asia's largest economy.
The economic pain from a 33 percent rise in fuel prices to reduce Jakarta's subsidy bill will help restore some confidence in Indonesia's markets and the government's fiscal discipline, analysts said.
The central bank hiked interest rates last week as it scrambled to prop up the rupiah, which fell to its lowest level in almost four years partly on worries that the cost of the fuel subsidies were weighing on the economy.
Parliament paved the way for the price rises on Monday by agreeing to measures to mitigate their impact on the poor.
"By implementing the fuel price hikes, the government is showing its commitment to undertake tough reforms, especially a year ahead of elections," Barclays said in a research note, referring to presidential and general elections due next year.
The stock market rose 1.4 percent, but the rupiah fell as much as 0.7 percent against the dollar, its steepest intraday fall since February 1.
Although dealers cited inflation concerns as one reason for the fall in the rupiah, they also said investors once again sold emerging market currencies ahead of a meeting of the U.S. Federal Reserve on this week.
Finance Minister Chatib Basri said the planned 44 percent increase in gasoline prices and 22 percent rise in diesel would only take place once the government had finalised a process to compensate poor families for the higher costs.
The compensation, part of a revised 2013 budget passed by parliament on Monday, will provide about 9 trillion rupiah ($910 million) in cash for more than 15 million families, which will be paid over four months.
The president, who has to formally sign off on the fuel price increases, wants to minimise the impact on the cost of living for the country's 240 million population, which could spark higher wage demands and potential unrest ahead of 2014 elections.
Thousands protested on Monday across the country as parliament met and there were scattered reports of violence. There were no reports on Tuesday of major demonstrations but motorbike rider Rahman Hakim, 37, was not happy with the news coming just before Ramadan, when food prices tend to rise.
"I understand that the government must do this, but please do not impose it these days," he said as he filled up with petrol at a filling station. "Before Ramadan and Eid, prices normally go up and the fuel price hikes will only make matters worse."
The finance ministry has forecast that with the fuel price increases inflation for 2013 would rise to 7.2 percent, which would be the highest level since more than 11 percent in 2008. The central bank says inflation would rise to 7.76 percent this year.
"It is essential to guard against inflation since 55 percent of GDP is household consumption," Basri told reporters. "We are (giving) rice to the poor because the biggest (contribution) in inflation basket is rice."
GDP growth is also likely to ease to 6.3 percent this year from an initial estimate of 6.8 percent, as domestic consumption takes a hit from higher fuel prices, the ministry said.
"The increase in subsidised fuel prices, especially when combined with monetary policy tightening, will likely hit already weakening investment growth, dragging GDP growth further," said Santitarn Sathirathai, an economist at Credit Suisse, which sees GDP rising 5.7 percent.
Bank Indonesia, the central bank, surprised markets last week by raising its policy rate to 6.0 percent from a record low of 5.75 percent, the first increase since February 2011.
It also raised the overnight rate it pays on bank deposits held at the central bank, as it scrambled to support the weakening rupiah during an emerging markets selloff.
Barclays expects inflation to be above 8 percent by the end of 2013 and that the central bank will raise its policy rate by another 25 basis points.
Eugene Leow, an economist at DBS in Singapore also said the central bank would raise rates.
"However, the implementation process could prove difficult if protests and unrest pick up," he said.
(Additional reporting by Adriana Nina Kusuma in Jakarta and Umesh Desai in Hong Kong; Editing by Jonathan Thatcher and Neil Fullick)