JAKARTA (TheInsiderStories) – After hold its benchmark since 2014, Bank Indonesia (BI) decided raised its benchmark rate 25 basis points (bps) to 4.50 percent after the rupiah sinks to the record low at Rp14,200 per U.S dollar. We believed this policy be taken to maintain Indonesia’s economic stability and is in line with market expectations.
The rupiah is among the worst performers in Asia, down 3.4 percent against the dollar during 2018 and falling to a 31-month low on May 16, the lowest in nearly two and half years after the release of the country’s trade deficit. In the foreign-exchange market, the Bank burning more than US$7 billion of reserves since the beginning of February to halt the rout.
BI used its foreign currency reserves to prop up the rupiah, but with reserves diminishing 5.3 per cent from a record high of $132 billion in January to $124.9 billion in April, the bank had to resort to raising the interest rate.
Meanwhile, the yield on Indonesia’s benchmark 10-year government bonds rose 12 bps to 7.217 per cent. Net outflows from Indonesia’s rupiah-denominated bonds have totaled$2.3 billion since the end of March. A the same time, international investors have dumped $3.4 billion of stocks and bonds since the start of April.
Furthermore the outgoing governor Agus Martowardojo stated “if the situation forces us to adjust our policy rate once again we will do it without doubt.” This mean, the new era of low interest rate has gone.
BI had embarked on a series of rate cuts from 2015 through 2017, as President Joko Widodo aimed to facilitate lending and boost growth. But despite the accommodative policy, the economy has been slow to surpass the year-on-year average growth of 5.1 percent over the past five years.
The fall in the rupiah and the Jakarta Composite Index recently raised concerns over Indonesia’s ability to cope with the risks resulting from the growing uncertainties in the global economy.
A stronger dollar has pressured emerging market currencies broadly and injected volatility into a pocket of the market that investors have flocked to for generating higher yield, but the dollar’s strength poses risks for some local currency denominated bonds.
The condition was getting worse after the Statistics Indonesia released the update data on the country’s trade balance in April, which saw a deficit at $1.63 billion, the highest since April 2014. The trade deficit so far in 2018 will also put pressure on the country’s current account deficit (CAD).
The CAD widened to 2.15 percent of Indonesia’s gross domestic product (GDP) in the first quarter of 2018, up significantly from 1.0 percent of GDP in the first quarter of 2017.
Indonesia’s benchmark index has dropped 9.4 per cent this year, and is the second worst-performing major equity market in Asia. Any interest rate increase will also need to take into consideration the sluggish economy.
The country isn’t alone in contending with investors who have turned cold. Debt sales from countries such as Russia have been cancelled or postponed, while Argentina’s central bank has raised interest rates three times in a week to halt a currency slide.
We found BI’s move could reduce risk in the market and a rise in interest rates will not hurt the economic growth. To maintain economic stability, we encourage the central bank be focus on improving CAD which has reached 2.19 percent of GDP in the first quarter of 2018, as the possibility of current account deficit will widen in the second quarter due to the import activity.
Nevertheless, we consider this BI move will encourage investors to re-valuation in investing in Indonesia. This can prevent the rapid flow of foreign funds out of the domestic financial market.
We also noticed that the steps taken by the central bank have consequences especially on the Widodo’s desire to lowering the loan interest rate in Indonesia. The rupiah liquidity remains abundant but the intermediation of credits into the real sectors are perhaps challenged by temporary refrains from banks to extend loans as they are nursing and adjusting NPLs issue.
The demand for loans have been weakening since the middle of 2014. Nevertheless, we are turning cautiously optimistic for 2018. With the growth forecast of 5.3 percent, supported by higher domestic spending in light of regional elections, regular festivities, Asian games and also IMF-World Bank Annual Meeting, demand for credits would probably pick in the near future.
We forecast credit growth to be in the range of around 10 percent for 2018 with some upside risks. While BI could rise the benchmark rate at least 25 bps this year, again to support the domestic economy.