Indonesia: MPC Preview: Bank Indonesia to Hold Rate Despite Currency Volatility
With inflation within target range and the need to defend the currency amid global uncertainties and US dollar strength, Bank Indonesia (BI) is likely to extend its pause on rate adjustments in the upcoming monetary policy meeting on April 24. BI remains committed to stabilising 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: Indonesia Consumer Price Inflation and Policy Rate (% y/y)
Source: Continuum Economics
The context for Bank Indonesia's (BI) forthcoming rate decision unfolds amid shifting economic metrics. It is expected that the 7-day reverse repo rate will maintain its status quo in March, continuing the pattern observed from November 2023 to March 2024.
In our view, the stability of the rupiah remains pivotal in shaping subsequent rate adjustments, alongside the Consumer Price Index (CPI) inflation, which has already aligned with the revised target band of 2.5+/-1%, marking a 0.5 percentage point reduction from the preceding year. Indonesia's inflation dynamics warrant careful consideration. While CPI inflation remains within BI's target band of 2.5+/-1%, recent upticks and proximity to the upper limit underscore inflationary risks. The seven-month high in inflation observed in March (at 3.1% yr/yr), coupled with the narrow interest rate differential with the US, necessitates a cautious approach from BI. Moreover, imported inflation, fuelled by the rupiah's depreciation, poses additional challenges to price stability. Additionally, more recent volatility observed in the exchange rate is of growing concern for BI. The recent weakening of the rupiah to a four-year low (USD/IDR 16,400) reflects external pressures, notably renewed hawkishness from the US Federal Reserve. BI's primary mandate of currency stability compels it to intervene in the forex market to mitigate volatility. However, the efficacy of such interventions may be limited, especially amidst global economic uncertainties. The recent volatility has prompted market views of a 25bps rate hike. However, in our view, BI is unlikely to hike rate this month in a bid to support the currency, especially as latest trade data revealed a wider than anticipated surplus. At US$ 4.47bn, March trade surplus was the highest recorded in over a year.
Meanwhile, Indonesia's economic growth trajectory exhibits resilience, albeit with moderating momentum. GDP growth, driven predominantly by robust domestic demand, remains steady around the long-term average of 5.0%. Projections for 2024 suggest a marginal slowdown compared to previous years. However, this is unlikely to prompt any rate-related actions by the central bank this quarter.
Against this backdrop, BI's upcoming interest rate decision is likely to be in favour of an extended rate pause. The delayed rate cut expectation aligns with global trends, particularly the US Federal Reserve's monetary policy outlook. With expectations for the first US rate cut pushed back to September, BI's approach to monetary easing is also contingent upon external developments. In our view, any rate cut is only likely in Q3, albeit a small one of 25bps.