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With its economy chugging along, Indonesia’s biggest problem is not with growth, but with managing rising inflation that comes with robust growth.

To this end, the central bank has toed the line over the past year, opting to embark only on mild monetary tightening, to the tune of one 25-basis-point interest rate increase since the global recovery took hold, in an effort to stimulate the economy.

At this point, with slowing headline inflation, there is no urgency for the central bank, Bank Indonesia, to raise rates. But beyond the short term, overheating risks will mount and further rate hikes will be needed to prevent excessive inflationary pressure.

The macroeconomic situation now is sanguine, with year-on-year gross domestic product growth at 6.5 percent in the first quarter. Even with global headwinds from the euro zone crisis and a slowing US economy, Indonesia should display resilience, and its growth story is unlikely to be derailed. Indicators such as the consumer confidence index and vehicles sales suggest continued growth momentum.

Against the backdrop of strong economic growth, the headline consumer price index has also been trending lower after having peaked at 7 percent year-on-year in January, putting the country in a sweet spot of high growth and low inflation.

With signs the government is unwilling to hike subsidized fuel prices, headline CPI is also likely to grind lower over the course of the year, temporarily easing pressure on the central bank to resume monetary tightening. This ideal situation is unlikely to persist beyond the next few months.

Importantly, the decline in headline CPI masks the fact that demand-pull inflation is starting to come in play.

Headline inflation has been driven lower largely due to stabilization in food prices, but inflation for almost every other component has been increasing. Core inflation, which strips out volatile energy and food prices, has also been on a firm upward trend since March 2010. The pace of core price increases has also quickened over the past year.

Moreover, rapid credit growth and the continued inflow of foreign funds should also translate into money supply expansion. These are early warning signals that should not be ignored.

With a sanguine economic outlook in the coming quarters, core inflation is likely to remain elevated and edge toward 5 percent by the end of the year.

What does this mean for the policy rate? First, there is no urgency to further tighten monetary policy, especially since a one-off bump due to a fuel price hike is unlikely this year.

With stabilization in food and fuel prices in recent months, headline inflation will remain flat. But beyond the short term, inflationary concerns will come to the fore as demand growth outpaces supply capacity.

As such, rate hikes should likely be back on the central bank’s agenda in the latter part of the year. Should the current “sweet spot” persist for a longer period, BI would have even more room to delay monetary tightening, possibly until early 2012.

Food and energy prices, which combined make up a large chunk of the CPI basket, are the wild cards in the inflation equation. Should food and commodity prices continue to ease, headline inflation may dip close to 5 percent by the end of the year.

This scenario would be beneficial for economic growth as it implies that the central bank can afford to put off monetary tightening for a longer period.

For the longer term, Indonesia needs time to handle its supply-side issues to allow for a structural downshift in its inflation rates and a higher plane of economic growth.

Encouragingly, there has already been a sharp pickup in both local and foreign investment and Indonesia is already embarking on investment-led growth over the longer term.

However, these additions to production capacity will take time to materialize.

Moreover, there is also an urgent need to address the infrastructure crunch facing the transportation and power sectors. Until they become resolved, these structural issues will continue to negatively impact the CPI, and by extension, limit Indonesia’s potential growth rate.

Eugene Leow is an economist at DBS Group Research in Singapore.