Indonesia Under Pressure to Cut as Outlook Dims: Decision Guide

(Bloomberg) -- Indonesia’s central bank is expected to resume lowering interest rates after a two-month pause as further signs of a slowing economy pressure policy makers to do more to bolster growth.

Bank Indonesia will cut its benchmark rate by 25 basis points Thursday to 4.25%, according to 15 of 22 economists surveyed by Bloomberg, with the rest expecting no change. In recent months the central bank has kept policy unchanged to support the currency, but a significant deterioration in the economic outlook amid the Covid-19 pandemic is driving expectations that it will add to 50 basis points of cuts from earlier this year.

The government on Tuesday reduced its growth forecast for the year -- the latest in several downward revisions -- and voiced concern over the potential for a second wave of virus infections as the economy reopens. Gross domestic product is expected to contract 3.1% in the second quarter.

“Infections are still rising in Indonesia, and the health care and financial resources to deal with the outbreak remain restrained,” said Charu Chanana, lead Asia economist at Continuum Economics in Singapore. “Bank Indonesia may finally pull the trigger by cutting rates at its June 18 meeting, given the rupiah’s recovery and persistently weak economic momentum.”

Here’s what to look for in Thursday’s decision:

Growth Fallout

Like many countries, Indonesia is battling a crisis on two fronts as virus cases continue to rise and the economy reels from the hit to commerce from social distancing rules and other restrictions. While the government is now lifting lockdowns, it has cut its growth outlook for the year to a range of 0% to 1%, while warning that in a worst-case scenario the economy could even contract.

“All economic sectors are now under pressure,” Finance Minister Sri Mulyani Indrawati told reporters Tuesday. “What if there is a second wave? My answer: I can only pray.”

Bank Indonesia may also revise down its growth outlook Thursday after earlier slashing its 2020 forecast to 2.3%, in line with previous government projections.

Rupiah Rally

The rupiah has continued to strengthen since the central bank’s last rate meeting, gaining more than 5% over the past month to be the best performer in Asia.

Bank Indonesia Governor Perry Warjiyo has said the currency is still undervalued and expects it to gain further. He has stressed the central bank’s preference for the rupiah to stabilize “in line with fundamentals.”

“BI remains very clear about its top policy priority, which is to preserve FX gains and promote stability,” said Euben Paracuelles, an economist at Nomura Holdings Inc. in Singapore, who expects Bank Indonesia to stay on hold Thursday. “In the face of rising external uncertainty such as fears of a second wave of Covid-19 cases globally, that should imply stable policy rates.”

Trade Worries

Indonesia posted a far larger trade surplus than forecast in May, mainly due to a 42% plunge in imports amid weak domestic demand and disruptions to global supply chains. The sharp decline in incoming shipments of raw materials and capital goods could weigh on manufacturing over the next three to six months, Indrawati said Tuesday, impeding a return to normal production levels.

At the same time, the improvement in the trade gap may help to further narrow the current account deficit -- a chronic vulnerability for Indonesia. The central bank last month forecast the shortfall will probably come in below 2% of gross domestic product this year.

Warjiyo sees the narrower current account deficit and low inflation further aiding the rupiah. Despite the past month’s rally, the currency is down 1.3% since the start of the year.

Read: Bank Indonesia Sees Stronger Rupiah on CPI, CAD: Warjiyo (1)

“The rupiah’s declines have kept BI on the back foot, but we believe that the opportunity for a rate cut at the June 18 meeting should not be missed,” Continuum Economics’ Chanana said.

©2020 Bloomberg L.P.