The central Bank Indonesia (BI) raised its reference rate by 75 basis points to 9.5% effective from Tuesday, after the rupiah dipped as low as 11,800 against the dollar – 21% lower than in early August - in trade on Tuesday.

The rupiah recovered slightly to trade at 10,800/10,950 - still down on Monday's close of 10,750/10,800 amid soaring global oil prices.

Indonesia is being battered on two fronts due to the high oil prices: it is scurrying to find dollars to pay for oil imports but must also pay out domestic fuel subsidies to a population extremely sensitive to their removal.

Despite being a member of the Organisation of Petroleum Exporting Countries, Indonesia's underfunded and ageing energy sector is unable to supply fuel needed to meet domestic demand, meaning it has become a net importer.

BI also raised Indonesian banks' minimum reserve requirements by one to five percentage points from 8% to further tighten rupiah supply.

Confidence factor

BI governor Burhanuddin Abdullah said the measures were taken as the bank "thinks it is urgent that we restore people's confidence".

Singapore-based JP Morgan analyst Claudio Piron said the rate increase would encourage stability.

"Essentially today we've made a good start and it's a short term positive, but we now need to see clarification on fiscal oil subsidies," he said on Thursday, adding that inflation data could also sway markets.

"So there is in a sense too much consumption of oil going on. By cutting fuel subsidies, it will discourage excess consumption"

Claudio Piron,
analyst, Singapore-based JP Morgan

JP Morgan calculates that every $10 increase in the price of a barrel of oil amounts to a deterioration of $2 billion in Indonesia's balance of payments.

"So there is, in a sense, too much consumption of oil going on. By cutting fuel subsidies, it will discourage excess consumption," Piron said.

If fuel subsidies remain at their level, pressure will persist on the rupiah which could only be eased via a further interest rate raise, he warned.

Bank International Indonesia market analyst Ferry Latuhihin said the market needed to know what would happen with the subsidies.

Nationwide protests

The government triggered nationwide protests in March when it raised fuel prices by an average of 29%, making any further rise politically sensitive.

"The government should decide whether the domestic price of fuel will be raised as soon as possible, or postponed till January. The market needs certainty," he said. "I would like to see that it is immediately raised."

President Susilo Yudhoyono has
appealed to people for calm

For his part, President Susilo Bambang Yudhoyono said the government would announce on Wednesday measures to deal with the rupiah's slump as he sought to calm fears of a repeat of the 1997-98 Asian financial crisis.

"In reality, the conditions and situation of our economy are different from the economic conditions and situation in 1998," he said.

Indonesia's frail banking and economic system, greatly undermined by years of corruption, collusion and nepotism, collapsed in the face of a plunging rupiah in 1997. The country is still recovering from the crisis.

"To the people, I ask you to remain calm ... I believe that we will find the solution and the appropriate steps to overcome this problem," Susilo added.