Indonesia: Approaching tail end of the hike cycle

Bank Indonesia (BI) raised the policy rate.
Group Research, Radhika Rao19 Jan 2023
  • Bank Indonesia (BI) raised the policy rate by 25bp to 5.75%, as expected
  • Policymakers were encouraged by resilience in domestic growth and peak in inflation
  • February’s FOMC will be watched closely
  • Implications for forecasts: BI is approaching the tail end of the hike cycle
  • Foreign interests are returning to the bond markets
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BI stays the course to hike

Decision and economic assessment

Bank Indonesia (BI) delivered a 25bp hike on Thursday, taking the benchmark rate to 5.75%. With this increase, the 7-day reverse repo rate is back to levels seen before the pandemic in mid-2019. Earlier in the day, Malaysia’s BNM surprised with a pause on rates.

In the post policy comments, Governor Perry Warjiyo struck a cautious note on the global outlook, lowering the 2023 GDP forecast to 2.3% from 2.6% earlier, besides citing a peak in the monetary tightening cycle by major central banks. Views on domestic growth were more upbeat, expecting tailwinds from China’s reopening to offset the impact on trade from slowing US and Europe growth. The 2023 growth estimate was retained at 4.5-5.3%, vs forecast of 5.2% for 2022 (DBSf: 5.4%).

Reiterating that BI was committed to its inflation-targeting mandate, headline inflation is expected to ease below 4% in 2H23, with core inflation capped at 3.7% in 1H. 

The currency’s recent outperformance was also highlighted (rupiah ytd +3% vs USD, second best performer vs peers), as the IDR benefited from a resumption of foreign flows into the debt markets. This will be backed by 2022 current account, which is likely to post a strong +0.4 to 1.2% of GDP, before moderating to -0.4% to +0.4% range in 2023 (vs our forecast for a small surplus).

Policy outlook

BI maintained on Thursday that its policy was ‘pre-emptive and frontloaded’, to address inflationary risks. Governor Warjiyo signalled that the string of hikes since Aug22 were ‘adequate’, encouraged by the earlier-than-expected moderation in inflation and recent recovery in the currency. These will feed market expectations that the domestic policy tightening cycle is near its end.

We retain our call for a last 25bp hike in February as a buffer against volatility in the financial markets and to support the currency. Admittedly, Thursday’s comments increase the probability that policymakers view 5.75% as the terminal rate, leaving the real rate (benchmark rate minus inflation) in the black in 1Q23. Nonetheless, before drawing a brake on the rate hike cycle, we expect policy guidance at the February FOMC to be watched closely as a potential catalyst for financial markets’ price action (bonds and US dollar). An outright dovish tone by the US Fed will deter BI from further hikes.

Concurrently, BI is expected to retain its multi-pronged presence: a) operation twist operations to lift short term yields, while long-term rates stay anchored; b) keeping an eye on the bond markets even as foreign interests return; c) bond holdings worth IDR 1450trn will be utilised for monetary operations; d) ensuring rupiah stability.

Moves to boost FX liquidity

Plans to attract FX liquidity back to the onshore financial system continue to be a priority. Back in Dec, BI had outlined plans to introduce a new FX monetary instrument intended to attract export dollar earnings to the onshore markets by offering competitive returns. The provision of mandatory repatriation of foreign currency is set to be expanded to include manufacturing activities. This is applicable to commodity sectors for the time being, including mining, farm/ plantation, forestry, and fishery etc. Indications are that the duration of three-month period for which export proceeds need to be kept onshore might also be revisited. Separately, banks will be exempted from setting aside funds under RRR for export proceeds received as deposits.

For comparison, Malaysia requires export proceeds to be repatriated immediately upon receipt of payment, six months from the date of shipment or extended up to 24 months on extraordinary circumstances, according to the BNM. Additionally, if the payment for proceeds of export of goods is received within 6 months from the date of shipment, then additional approval from the central bank is not required.

For Indonesia, higher domestic FX availability will support the currency and lower associated borrowing costs for the financial sector. Low returns have deterred foreign currency liquidity from returning to the domestic markets, despite a strong goods trade surplus year-to-date and record investment flows.

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Radhika Rao

Senior Economist – Eurozone, India, Indonesia

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