Bank of Indonesia raises interest rate by another 25 bps
Whether the Bank of Indonesia will raise interest rates again in the next policy meeting will be a hot topic for now, after the central bank raised both the reference rate and deposit rate by another 25 bps. This is the fourth rate hike in the past two months.
The central bank unexpectedly excised the back-to-back rate hike yesterday, raising the reference rate to 7.25%, the highest level in the past four years. At the same time, the Bank of Indonesia Deposit Facility (FASBI) rate was hiked up to 5.5%. The tightening implemented by the bank this round is the most aggressive since 2005 amid the U.S. stimulus withdrawal situation. Indonesia has to join Brazil, India and other emerging markets in tightening monetary conditions when developed nations still emphasize loose monetary policies, such as Europe and Australia. High domestic consumption and growth in exports of manufactured products and commodities largely drove the Indonesian economy in past years. Thus, tightening monetary policy is set to ruin activities in both areas and puts growth at risk, given that the global recovery is still considered to have a modest to moderate pace. But it is now the central bank’s priority to limit capital outflow to curb risk of a crash in the financial market, when a substantial amount is treated as highly speculative.
Fuel price hikes and higher food costs sent inflation reaching up to 8.79% last month. But the central bank’s recent tightening and slowing growth may cool off inflation in upcoming months.Source: Bloomberg Click the image to enlarge Source: Bloomberg, FXPRIMUS Click the image to enlarge
Tightening monetary condition makes bolstering Rupiah difficult due to weak Fundamentals
The positive impact on the Rupiah from the central bank’s rate hikes will be very limited in my point of view, given its relatively weak Fundamentals compared to other countries in the region.
The largest banks in the country, such as Bank Pan Indonesia Tbk PT and Rizal Commercial Bank, suffered from the currency depreciation and widening current account deficits when their share prices dropped more than 30% since the beginning of the year. The rate hikes will further slow their loan growth due to the rise in funding cost, leading to a net interest margin profit decrease. The loan-to-growth ratio breaching 86% is another factor curbing current lending activities.
The lowest current account balance as a percent of Gross Domestic Product (GDP) ratio in the Asia-Pacific also implies that aggressive rate hikes are far from being off the table, to enhance saving activities and curbing foreign capital outflow. The recent appreciation is largely driven by the entire Emerging Markets slowing outflow, not the Bank of Indonesia’s policy. When the Federal Reserve (Fed) tapering emerges later this year, the Rupiah may resume its selling-off mode.Source: Bloomberg Click the image to enlarge
Given the weak outlook of its macroeconomic condition and the U.S. tapering impact, the USDIDR will likely gain some support near the level of 11,200.Source: Bloomberg Click the image to enlarge