Bank Indonesia: Rate Hold Suggests IDR Stability a Priority
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In its latest Monetary Policy Committee (MPC) meeting on July 25, Bank Indonesia (BI) decided to maintain its key interest rate at 5.75%. The consistent decline in consumer price inflation allow sufficient head room to hold rates, while private consumption remains robust. It appears from BI’s decision and commentary that its current focus is ensuring forex stability, amid a potential rate hike by the Federal Reserve and declining current account surplus.
Figure 1: BI Main Policy Rate, Indonesia Consumer Price Inflation (%)
Source: Badan Pusat Statistik and Bank Indonesia
In line with our view, Bank Indonesia extended its rate pause for the seventh consecutive meeting today, retaining its benchmark policy rate at 5.75%. The decision was in line with market expectations as well. One of the key factors influencing BI's decision to keep rates unchanged is the recent slowdown in consumer price inflation. With inflation now back within the central bank's target band of 2-4%, BI has room to maintain the status quo before potentially considering monetary policy easing in Q4. Consumer prices declined to 3.5% y/y in June.
The focus has shifted to ensuring exchange rate stability, particularly in light of the Federal Reserve's further tightening, which has widened the interest-rate differential with BI. BI governor, Perry Warjiyo emphasised the importance of stabilising the Indonesian Rupiah (IDR) as it helps limit imported inflation and supports the central bank’s goal of price stability. A stable IDR also mitigates the risk of contagion from global financial market uncertainties, he added. To further support the currency and boost credit expansion, BI lowered the reserve requirement for certain lenders, freeing up IDR 47tn (US$3bn) in liquidity. This is geared towards institutions providing credit to commodity downstreaming industries.
Despite maintaining its growth forecast for the year at 4.5-5.3% year-on-year, BI expects second-quarter GDP to rebound from the previous quarter, given the return of inflation to the target range. Governor Warjiyo anticipates possible rate hikes by the Federal Reserve in July and September. As a consequence, BI is unlikely to cut rates before October. BI may be open to rate cuts in October, depending on IDR stability and economic conditions. For now, our expectation is that BI will cut its interest rate by 25 bps once in Q4 2023.
In conclusion, Bank Indonesia's decision to hold its key rate steady reflects a cautious approach amid the recent inflation slowdown and focus on IDR stability. The central bank will attempt to navigate an uncertain global environment while ensuring a supportive domestic economic environment for sustained growth.