Bank Indonesia (BI, the central bank) raised its benchmark rate by 25 basis points to 6.75% in February, in a move aimed at restoring market confidence in BI's commitment to controlling inflation. The central bank cut its benchmark rate, the BI rate, to 6.5% in August 2009, the lowest level since the rate was introduced in 2005, to support economic growth, and it had left the rate unchanged at that level until the recent rise. The decision to leave the rate on hold for so long meant that it had become increasingly apparent that BI's policy stance was not in line with that of other central banks in Asia, and there was a growing perception that it was failing to act sufficiently aggressively amid signs of rising inflationary pressures. However, two consecutive months of inflation of around 7%, above the upper end of the central bank's 4-6% target range, as well as expectations of further food and fuel price rises in the coming months, left BI's governors with little choice but to raise the bank's benchmark rate in February.

A major factor influencing the decision to raise rates may have been signs that portfolio investors were becoming anxious about the impact of inflation on positions taken in the local stock and bond markets. A short but sharp slump in the main stock index, the Jakarta Composite Index, in early January, after BI had resisted pressure to raise interest rates at the start of that month, provided a reminder of how vulnerable Indonesia remains to the flight of foreign capital. Short-term capital inflows into local markets reached US$13bn in 2010, according to BI, with foreign investors holding 30% of the stock of government bonds, 30% of central bank promissory notes, and accounting for 60% of market capitalisation on the local bourse. The scale of these holdings leaves the country highly vulnerable to any reversal in investor sentiment. However, higher interest rates may now make the country even more attractive to foreign investors and further short-term capital may be drawn into the country.