Further hikes in Indonesia’s Fasbi rate likely before year-end - Capital economics | Outlook Data
- Bank Indonesia’s (BI) decision today to hike the rate it pays lenders on overnight deposits (also known as the Fasbi rate) reflects concerns about the weakness of the rupiah and falls in the level of foreign exchange reserves. Changes in the Fasbi arguably matter more to Indonesia than shifts in the main policy rate. Looking ahead, we expect to see further hikes in the Fasbi before the end of the year, but for the main policy rate to remain on hold.
- Today’s increase in the Fasbi rate by 25bp to 4.25% is the first change since August last year, and comes one day before of BI’s scheduled monthly policy meeting. We along with 19 analysts polled by Bloomberg expect the main policy rate to be left on hold at its meeting on Thursday.
- However, changes in the Fasbi rate arguably matter more in Indonesia since it can directly affect market conditions. The Jakarta Interbank Offered Rate (JIBOR), the rate used for money market transactions, typically tracks changes in the Fasbi rate much more closely than BI’s main policy rate. (See Chart 1.)
- Today’s increase in the Fasbi is aimed at supporting the currency without further diminishing the level of foreign exchange reserves. The Indonesian rupiah has been the worst performing currency in Emerging Asia over the past 12 months. Although the rupiah may not have fallen as much as some other Asian currencies over the past month, this mainly reflects heavy intervention by the central bank which has been running down its level of foreign currency reserves. (See Chart 2.)
- With BI reluctant to allow the rupiah to drop below the psychologically-important 10,000 level and foreign exchange reserves to fall lower than US$100bn, policymakers were running out of options.
- Looking ahead, downward pressure on the rupiah is likely to build as worries about the consequences of a scaling back of QE continue to build. As such, we expect to see further hikes in the Fasbi rate before the end of the year. By contrast, we expect the main policy rate to remain on hold.
- The pace of rate hikes will be determined mainly by the outlook for inflation. The headline inflation rate has been consistently towards the top end of BI’s 3.5-5.5% inflation target in recent months. BI has taken a fairly relaxed view about the increase mainly because core inflation has remained low. However, inflation could rise towards 7-8% in the coming months if the government pushes ahead with plans to increase fuel prices, which at the moment are heavily subsidised. Under these circumstances, a more aggressive pace of policy tightening is likely.
- It should be noted that a change in the fuel subsidy regime is far from a done deal. Last year the government looked set to press ahead with reforms to its subsidy regime, but pulled out at the last minute after losing the support from one of its coalition partners. Fuel subsides are popular among Indonesian public, and although reform of the system is needed to bring the budget deficit down, with presidential elections less than a year away, there is no guarantee reform will take place. Our forecast of two further 25 bp hikes in the Fasbi rate by end-2013 assumes the subsidy regime is left unchanged.
