Thought November 19, 2020 / 08:15 am UTC

Bank Indonesia: Surprise Rate Cut May Weigh on the Rupiah

By Charu Chanana

Bank Indonesia’s surprise rate cut in November may weigh on the gains garnered by the rupiah in the month so far. Low inflation however keeps the real rates attractive and more room for easing remains available if EM flows continue to improve into the next year. 

Bank Indonesia (BI) has once again surprised us with a rate cut at its November 19 meeting – bringing the 7-day reverse repo rate to 3.75%. The move comes after three consecutive months of policy hold, and was underpinned by subdued inflation as well as some stability in the financial market conditions. The central bank has also said the outlook for the current-account deficit is improving, and a surplus in the third quarter is likely.

Governor Warjiyo expects 2020 inflation to remain below the central bank’s 2-4% target range, although a return to the range will be seen next year. Indonesia’s real yield remains one of the best in EM Asia despite the rate cut. 

Rupiah has also been in gains this month, up over 3% against the greenback and the best in the EM Asian currency basket, providing room for the central bank to resume policy easing. The decision however weighed on the rupiah which was last seen down 0.7% for the day reversing the week’s gains. More inflows into Indonesian markets remain likely given the improved sentiment from the Omnibus Law and Biden’s victory in the U.S. expected to ease the strained U.S.-China relations. However, the pandemic curve trajectory remains on watch.

Economic conditions remain vulnerable as the pandemic continues to take a toll on activity levels and social distancing restrictions have increased again in several cities. Indonesia slipped into a technical recession with Q3 GDP slumping by 3.49% y/y after a 5.32% y/y contraction in the second quarter. Meanwhile, the effectiveness of the fiscal packages has been reduced due to the delays in disbursements.

We believe BI still has more room to cut interest rates if rupiah stability is maintained, as economic pressures are likely to linger. Accommodative macroprudential policies will also continue. 

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I, Charu Chanana, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.