Bank Indonesia Holds Rate Steady to Guard Vulnerable Currency

(Bloomberg) -- Indonesia’s central bank left its benchmark interest rate at a record low to protect the currency, and said it had formulated a plan to deal with eventual U.S. policy tightening. 

Bank Indonesia kept the seven-day reverse repurchase rate at 3.5% on Thursday, as expected by all 28 analysts in a Bloomberg survey. Interest rates have been on hold since February’s 25-basis point reduction, and are widely expected to stay at this level throughout 2021. 

“The decision is consistent with the need to maintain the exchange rate and financial system amid low inflation, and for the economy to recover from the pandemic impact,” Governor Perry Warjiyo said at a briefing in Jakarta. Monetary policy will remain loose and accommodative, he said.

The decision comes with Bank Indonesia keen to protect the rupiah, given the weaker economic outlook amid the pandemic and the risk that potential U.S. monetary policy tightening could spark a sell-off of emerging-market assets.

The rupiah pared losses to close down 0.2% at 14,403 to the dollar. The benchmark Jakarta Composite Index of shares slid 2.1% to its lowest level since July 14.

Braced for Taper 

Indonesia was among emerging markets hardest hit in 2013 when the U.S. Federal Reserve began unwinding its easy policy from the global financial crisis. This time, Warjiyo said Bank Indonesia had formulated a plan to deal with local fallout and had experience with policies to mitigate the impact, as well as ample foreign-exchange reserves.

“I need to emphasize that the Fed’s tapering policy will not have as big an impact as the 2013 ‘Taper Tantrum,’ ” Warjiyo said. “It will affect us depending on how far we can manage the difference in domestic and foreign interest rates, especially portfolio investment, such as the yield on government securities.”

What Bloomberg Economics Says...

Bank Indonesia’s decision to keep rates unchanged appears inevitable as the Federal Reserve’s tapering draws closer. The Indonesian central bank has little scope to lower rates further and risk fueling selling pressure in the rupiah. Our view remains for the central bank to leave rates unchanged through the remainder of this year and most, if not all, of 2022. 

-- Tamara Mast Henderson, Asean economist

To read the full note, click here

Warjiyo said the Fed has communicated its exit policy clearly and transparently, while markets already know how to digest the taper talk this time around. Bank Indonesia can deal with the fallout via a policy of triple intervention -- in the foreign exchange market, domestic non-deliverable forwards market, and the government bond market -- and by coordinating with the Finance Ministry to manage yield differentials from the U.S., he said.

BI’s assessment “appears to be on the optimistic side,” said Nicholas Mapa, senior economist at ING Groep NV. “We’re skeptical that the market reception to the actual Fed Taper 2.0 will be as orderly as they expect.” 

Growth Forecast

Southeast Asia’s largest economy grew faster than expected in the second quarter -- up 7.1% from a year earlier -- but the pace is expected to slow in coming quarters with mobility curbs still largely in place, weakening consumption and business activity.

The government expects the economy to grow 3.7%-4.5% this year. Warjiyo on Thursday reiterated the central bank’s forecast for 3.5%-4.3% growth. 

“Even as the virus threat would remain there, the Indonesian economy may have started to stabilize, supporting the central bank’s decision to stay on hold,” said Wellian Wiranto, an economist at Oversea-Chinese Banking Corp. in Singapore. “The fact that loan growth has inched back to positive year-on-year growth territory for the second month running marks an encouraging turn as well, especially for BI, which has been egging the banks to lend more.”

Fiscal spending and macroprudential measures are likely to play a bigger role in supporting a recovery going forward, particularly in boosting demand and lending. The government still plans large state spending next year, albeit slightly less than in 2021, and will continue to coordinate with the central bank to finance the budget. 

Support Needed

The government and central bank also will focus more on the corporate sector to deter any spillover to the broader financial system from restructuring and bankruptcy risks.

“Indonesia’s economy is struggling badly and could certainly do with more support from the central bank,” Gareth Leather, senior Asia economist at Capital Economics Ltd., wrote after the data. “The upshot is that interest rates are likely to remain unchanged until at least the end of next year.”

Other points from the briefing:

• Central bank preparing to introduce digital rupiah, which will boost economic efficiency
• Current account deficit expected at 0.6%-1.4% of GDP this year
• Lending rose 0.5% in July compared to year earlier, led by housing loans
• Central bank to introduce macroprudential inclusive financing ratio, effective Sept. 1, to help smaller businesses
• Central bank still allowed to participate in financing government budget

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