Indonesia's inflation outlook is highly influenced by the decision to further reduce these subsidies. The World Bank estimates that a IDR 2,000 increase in fuel prices can add about three percentage points to the level of headline inflation and can add over one percentage point to core inflation. Electricity price hikes, however, are estimated to have a smaller impact (< 1 percent) on the pace of inflation. As an illustration, the central bank of Indonesia (Bank Indonesia) initially targeted an inflation rate of 4.5 percent in 2013. However, after the fuel and electricity price hikes, inflation accelerated to 8.37 percent (yoy) by the year-end.

^{Sources: World Bank and Bank Indonesia}

Indonesia's characteristic volatile inflation rate causes a traditionally larger deviation from the annual inflation projections of Bank Indonesia. The consequence of such inflationary uncertainty is that it creates economic costs, such as the country's higher (domestic and international) borrowing costs compared to its emerging market peers. When a good track record of meeting annual inflation targets is established, greater monetary policy credibility will follow.

The lack of quantity and quality of Indonesia's infrastructure also entails robust economic costs. This hampers connectivity in the archipelago, thereby increasing transportation costs for services and products. Distribution disturbances due to infrastructure-related issues are frequently reported and made the government realize the importance of more investments in the country's infrastructure. Infrastructure has been labelled a top priority in the Masterplan for Acceleration and Expansion of Indonesia's Economic Development (abbreviated MP3EI); an ambitious long-term government development plan which is yet to bear fruit.

Food prices are traditionally highly volatile in Indonesia and subsequently impose a big burden on the poorer households who live under or just above the poverty line. These households spend more than half of their total expenditure on food items. Higher food prices therefore cause serious poverty basket inflation which may lead to increases in the level of poverty. Failing harvests in combination with a slow reaction of the government to substitute food products with food imports are causes for inflation peaks.

Discarding administered price adjustments, there are two traditional annual peaks of inflation in Indonesia. The December-January period always brings higher prices due to Christmas and New Year celebrations, while the traditional floods in January (amid a peak of the rainy season) results in disrupted distribution channels in several regions and cities, thus causing higher logistics costs. The second peak comes in the July-August period. Inflationary pressures in these two months emerge as a result of the holiday period, the holy Muslim fasting month (Ramadan), Idul Fitri celebrations and the arrival of the new school year. A marked increase is detectable in spending on food and other consumables, accompanied by retailers adjusting prices upwards.

With annual GDP growth close to six percent, the economy of Indonesia has been rapidly expanding in recent years, characterized by surging domestic demand (domestic consumption accounts for around two-thirds of the country's economic growth), robust private sector credit growth and increased business access to credit. Moreover, public sector wages have increased due to administrative reforms and private sector wage growth has accelerated (Indonesia's regional minimum wages were raised significantly in 2012 and 2013). As robust economic growth brings along inflationary pressures, recent monetary policies (in 2013 and 2014) were aimed at safeguarding financial stability, particularly after inflation surged due to the 2013 fuel prices hike and amid the looming end of the Federal Reserve's quantitative easing program (which led to large capital outflows from emerging markets, including Indonesia), at the expense of further economic growth.

Bank Indonesia (BI), Indonesia's central bank, has as main objective to ensure rupiah stability. It uses a wide range of instruments to stem mounting inflationary pressures in the country. Its bank rate policy is adjusted when inflation targets are not met. Between February 2012 and June 2013, the country's benchmark interest rate (BI rate) had been set at a historic low of 5.75 percent. After this period, inflationary pressures increased due to higher fuel prices and global uncertainty about the US quantitative easing program. Subsequent capital outflows resulted in sharp rupiah depreciation. Therefore, Bank Indonesia adjusted its BI rate upwards. Another measure to tighten monetary policy was the raising of the reserve requirements on both local and foreign currency deposits at Indonesian banks. Lastly, BI curtailed foreign investors' demand for Central Bank bills (SBIs) by extending the required holding period from one to six months, stretching the maturity of SBI issues to nine months and by introducing longer maturity non-tradable term deposits (which are available to banks only). These measures aimed at mitigating the flow of 'hot money' into Indonesia.

The table below puts Indonesia's recent inflation performance (annual percent change) in global perspective by comparing it to inflation figures from the United States (USA) and China.