Indonesia Is Poised for Its First Rate Cut in Two Years

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Indonesia is poised to cut interest rates for the first time in two years as the prospect of the U.S. unwinding some of its policy tightening bolsters the case for Jakarta to embark on an aggressive easing cycle.

With the archipelago’s economy facing dimming prospects, policy makers are under pressure to join counterparts in the rest of Asia in reducing borrowing costs to fire up investment. The Bank of Korea unexpectedly lowered its benchmark interest rate by 25 basis points on Thursday as the nation’s export slump drags on.

Bank Indonesia Governor Perry Warjiyo has already signaled that cuts are a matter of how much and when, and economists reckon he will pull the trigger Thursday, with more to come.

“We now have a combination of rupiah stability and a dovish U.S. Fed, which gives Bank Indonesia scope,” said Krystal Tan, an economist at Australia & New Zealand Banking Group Ltd. in Singapore. But the elevated current-account deficit remains “a potential source of vulnerability” and “is a reason why we don’t expect the 2018 rate hikes to be fully unwound,” she said.

Indonesia is trying to build reform momentum and harness an escalating trade war to lure manufacturing away from China and boost exports that would help mitigate the current-account problem. Re-elected President Joko Widodo wants to make it easier for employers to hire and fire and plans ambitious tax reforms to attract foreign firms.

An easing cycle should lift confidence and investment and could help propel the economy through its 5% growth barrier. All but six of 33 economists surveyed by Bloomberg predict Warjiyo and his board will reduce the seven-day reverse repurchase rate by 25 basis points to 5.75%. The remainder expect no change.

Bank Indonesia lifted its benchmark rate six times last year -- by a total of 175 basis points -- to fend off an emerging-market rout. Now, with the economy struggling in the face of the U.S.-China trade dispute and slowing global demand, focus has shifted from stabilizing the currency to supporting growth.

Still, not everyone believes easing is a done deal in Indonesia, which may want to maintain its rate differential with the U.S. until after the Fed’s likely move on July 31.

But that view remains a minority. Morgan Stanley says the benchmark rate will be lowered to 5% by year’s end. Goldman Sachs Group says the recent dovish shift from the Fed allows Indonesia to focus squarely on domestic priorities; it reckons that if the external environment stays benign, then there is a risk of more than the 50 basis points of easing it currently predicts.

Goldman’s central forecast is in line with the median estimate of economists that Bank Indonesia will cut the key rate to 5.5% by the end of December.

Here’s what to watch for in the statement:

Growth Outlook

The last time Bank Indonesia cut interest rates was in 2017, when it was trying to spur spending and growth. Fast-forward almost two years later and the economy is still struggling to clear 5% growth.

Policy makers have become increasingly concerned about the fallout from the trade war, with the government trimming its growth projections for this year and next. Southeast Asia’s biggest economy is forecast to expand up to 5.2% in 2019, slightly below the 5.3% seen previously, while the 2020 forecast has been pared back to 5.2%-5.5% from 5.3%-5.6%.

Current Account

While concerns about the current account have subsided, they haven’t disappeared altogether. It remains a key vulnerability, and although the central bank estimates it was below 3% of gross domestic product in the second quarter, that’s still above the projection of a 2.5% average for the year.

The shortfall was one of the key reasons Indonesia was hit so hard during last year’s emerging market upheaval.

President Widodo, commonly known as Jokowi, has zeroed in on the current account, urging ministers to find ways to lift exports. A report released Monday showed overseas shipments plunged 9% in June from a year earlier as Indonesia posted a slim $196 million trade surplus.

Price Pressures

Inflation is one bright spot. While the core measure rose at its fastest pace in more than two years in June, the headline number was well within the central bank’s target of 2.5% to 4.5%. Inflation cooled to 3.28% in June compared to a year earlier, with Bank Indonesia’s Warjiyo saying it is low and now is the time to go for growth.

To contact the reporter on this story: Karlis Salna in Jakarta at ksalna@bloomberg.net

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Michael Heath

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