Bank Indonesia: Extending Rate Pause
Bottom line: With inflation cooling and the need to defend the currency amid global uncertainties, BI is likely to extend its pause on rate adjustments in the near term. Bank Indonesia (BI) remains committed to stabilizing the Indonesian rupiah (IDR) and maintaining sufficient liquidity to facilitate robust bank lending. However, the challenges posed by cooling exports and persistent pressures on the IDR will be a key concern. BI will closely observe the currency's stability before contemplating a reduction in the key policy rate, in our view.
Figure 1: BI Main Policy Rate, Indonesia Consumer Price Inflation (%)
Source: Badan Pusat Statistik and Bank Indonesia
Bank Indonesia (BI) has announced its decision to keep the policy rates unchanged at 5.75% for a fourth consecutive meeting today, aligning with our expectations. This decision comes as the central bank prioritizes its main objective of curbing inflation to below 4%. Meanwhile, BI maintained its growth outlook for GDP, expecting it come in between 4.5% - 5.3% y/y, given the expectation of sustained robust growth over H2 2023.
The decision to maintain rates reflects BI's commitment to reining in prices, while simultaneously ensuring economic growth. The move comes at a time when the IDR is facing renewed pressure, amid the news of US debt ceiling, and the evolving policy direction of the Federal Reserve. The currency weakened by 1.8% against the USD since the start of May. Additionally, cooling exports also weigh on the currency, as Indonesia’s current account surplus has nearly halved (falling by over 47% y/y) in April. Meanwhile, it appears that BI will continue guarding the IDR from excessive weakening through its “operation twist”, which involves selling short-term bonds to attract foreign portfolio flows and provide support for the local currency. Given that uncertainties around the US policy moves, pressure on the IDR is likely to persist in the near term, and will influence BI’s future policy moves. Another aspect that would weigh on future policy moves would be the narrowing interest rate differential with the US, which could erode support for the IDR, amid capital flow reversal.
Figure 2: Indonesia Inflation and Core Inflation (% change, y/y)
Source: Badan Pusat Statistik and Bank Indonesia
On the inflation front, price pressures have moderated, with both headline and core inflation easing from their respective peaks and trending back towards the target range providing BI enough headroom to hold rates. The central bank expects inflation to return to its target range of 2% to 4% in Q3.
The outlook for monetary policy, in our view, is of rate hold. As part of the press conference too, governor, Perry Warjiyo did not explicitly signal rate cuts, emphasizing the monthly assessment of economic data, the volatility in the currency market makes such a move unlikely in the near future. Although risks persist, Indonesia's economy remains on a strong footing, with growth expected to sustain over Q2-2023 following a better-than-expected performance in the January-March period. Consequently, we continue to expect BI to hold key policy rate at 5.75% over the course of 2023.