Bank Indonesia Holds Rate Despite IDR Weakness
Bank Indonesia in a pro-stability move decided to maintain the key policy rate at 6.25%. The move comes at a time when the weakness in the Indonesia Rupiah has increased in recent weeks. A rate cut is therefore not on the horizon.
Figure 1: Indonesia Consumer Price Inflation and Policy Rate (%)
Source: Continuum Economics
Bank Indonesia (BI) announced its decision to maintain the key seven-day reverse repo rate at 6.25%. This move aligns with our expectations and is a continuation of BI's strategy to manage inflation and stabilize the rupiah amid external pressures.
Governor Perry Warjiyo emphasised that maintaining the current interest rate is part of a broader strategy to ensure macroeconomic stability. Despite the unchanged rate, BI is proactively working to stabilise the IDR, which has been under significant pressure due to global factors. The US dollar's appreciation and high US Treasury yields have adversely affected emerging market currencies, including the IDR. As of June 19, the rupiah had depreciated by 5.92% against the dollar for the year. BI has attributed this weakening primarily to external forces, notably the shifting outlook on US monetary policy which has spurred capital outflows from Indonesia. In response, BI has intensified its interventions in the foreign exchange and bond markets to curb excessive volatility and support the rupiah. The governor added that BI aims to bring IDR US$ to below 16,000.
Meanwhile, inflation dynamics in Indonesia have remained relatively stable. Consumer Price Index (CPI) inflation eased to 2.8% yr/yr in May, down from 3% in April, comfortably within BI's target range of 2.5% +/- 1%. Core inflation also remains subdued, which has allowed BI to focus more on stabilising the exchange rate rather than aggressively combating inflation. This stability in inflation provides the central bank with some leeway in its monetary policy decisions.
BI's outlook suggests a steady policy stance for the remainder of the year, barring any significant external shocks. However, persistent downward pressure on the rupiah could prompt further adjustments to the interest rate but the chance of this is slim. Governor Warjiyo expressed optimism that the rupiah would strengthen, underpinned by Indonesia's solid economic fundamentals and expected moderation in foreign exchange demand from domestic companies in the coming months. BI plans to optimize the use of various monetary tools to attract capital inflows and stabilise the currency. These include ongoing interventions in the spot foreign exchange market, non-deliverable forward markets, and bond markets. Additionally, BI is set to introduce new regulations to ensure banks manage their short-term foreign liabilities effectively, aiming to mitigate foreign exchange risks.
Looking forward, we anticipate that BI will maintain its current policy rate till end-2024. A potential rate cut by the US Federal Reserve later this year could provide BI with the opportunity to follow suit.