Indonesia's central bank, moving quickly to contain inflation after the government raised fuel prices more than 30 percent, hiked its benchmark interest rate by 25 basis points to 7.75 percent on Tuesday.
In his first major economic policy decision, President Joko Widodo on Monday night raised subsidized gasoline and diesel prices by more than 30 percent to help fund his reform agenda and tackle the country's budget and current account deficits.
"The increase of BI Rate is to anchor inflation expectations and to ensure that inflationary pressures remain under control and temporary, after the subsidized fuel price hike," said Bank Indonesia in a statement. "The decision is also consistent with the progress in managing current account deficit towards a more sustainable level."
The interest rate hike was the first rate-change since November 2013.
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The last time the rate was 7.75 percent was March 2009.
Bank Indonesia (BI) also kept its overnight deposit facility rate, known as Fasbi, unchanged at 5.75 percent and raised its lending facility rate by 50 basis points to 8.00 percent.
The central bank has pushed for significant cuts in fuel subsidies, which have made it focus monetary policy on the big current account deficit instead of raising economic growth, which has fallen to 5.01 percent, its slowest pace in five years.
Indonesia's growth hasn't dropped below 5 percent since the third quarter of 2009, when it was 4.27 percent.
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BI Deputy Governor Perry Warjiyo said fuel price hikes will add 2.6 percentage points to the inflation rate, which is expected to reach at 7.9 percent at year-end.
The fuel price hike is expected to have a minimal impact on the current account balance, with the finance ministry maintaining its forecast for a deficit of 2.5-3.0 percent of gross domestic product next year.
The full impact of the higher fuel prices on the economy will only be felt in early 2015, they say.
The fuel-price news helped push Indonesian stocks higher, closing up nearly 1 percent on Tuesday, while the rupiah briefly climbed to a 2-week high against the dollar.
Rupiah support
The rate rise will provide some support for the rupiah, which has fallen 6 percent in six months against the dollar as investors worried about Indonesia's political situation and potential for capital outflows from one of Asia's highest-yielding bond markets.
Between June and November 2013, BI raised its policy rate by 175 basis points.
Monday's fuel-price hike is expected to save the government of Southeast Asia's biggest economy around $11.5 billion next year, or around 9 percent of the central government's budgetary spending, Finance Minister Bambang Brodjonegoro said.
Widodo has pledged to use the funds for infrastructure, health, education and agriculture. More than $1 billion will be earmarked on irrigation alone next year.
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Credit-rating agencies welcomed the increase in fuel prices but said it was only a stop-gap in the absence of further steps to liberalize prices.
"Unless a comprehensive overhaul of the domestic fuel price mechanism is put in place, Indonesia's fiscal position is still vulnerable to fluctuation in global oil prices," said Takahira Ogawa, director of sovereign ratings at Standard & Poor's in Singapore.
There were no major protests on Tuesday about the fuel-price hikes in Jakarta, but in Makassar, Medan and Bogor some people took to the streets and local media reported minor scuffles. The government has promised to provide at least 6.4 trillion rupiah in social assistance to 15.5 million poor households to soften the impact this year.
Wai Ho Leong, economist at Barclays in Singapore, said BI's hike "came earlier than we had expected, reflecting a greater need to be as preemptive as possible to protect their credibility. This is going to be positive for rupiah assets."
