Indonesia : Rate cuts in the horizon

Conditions are aligned for Bank Indonesia to embark on an easing cycle, with a cut likely to come as soon as Thursday. We think that BI could cut by 25bps in 2019 and 50bps in 2020.
Masyita Crystallin, Eugene Leow17 Jul 2019
  • Bank Indonesia is likely to cut the policy rate by 25bps tomorrow
  • … and 50bps next year
  • IDR rates are high compared to peers
  • … and inflation risk remain manageable
  • IDR govvies and equities will hold up well in the easing cycle
Photo credit: AFP Photo

Fundamentals and sentiment are aligned

Conditions are aligned for Bank Indonesia (BI) to embark on an easing cycle, with a cut likely to come as soon as Thursday. With the rupiah performing well amid a dovish Fed and an improving trade balance, we think that BI could cut by a cumulative 75bps (25bps in 2019 and 50bps in 2020) over the coming quarters.

Inflation has been on the back burner, as a combination of slower economic activities, partly due to weaker commodity prices and better domestic rice supply management, have pushed inflation below 3%. We are revising down our inflation forecast to 3.2% in 2019 and 3.4% in 2020 from our previous forecast of 3.6%. Even if fuel and electricity prices adjustment need to be done this year, we do not think that inflation would swing too far from BI’s median target of 3.5%.

The trade balance has turned positive in the past two months to USD218mn and USD196mn in May and June from a deficit of -USD2.3bn in April. In fact, the window for trade balance improvement could be narrow further if commodity prices slip and manufacturing exports contraction continues. As infrastructure remains President Jokowi’s priority, capital goods import is likely to accelerate in 2020 which might not be reflected in 2H19 as infrastructure development might take some time to gather pace this year.

The Rupiah has been relatively stable in the past month reaching USD/IDR13,900 on July 16 (DNDF 3M also edging lower to USD/IDR14,074). Rupiah has appreciated by 3.75% YTD (until July 16), second highest after Thai Bhat among Asian countries. IDR could stay resilient as interest rates are high compared to peers like India.

It makes sense for BI to take the opportunity to ease. Risks of a widening current deficit and more volatile capital flows could close this window. Moreover, Indonesia is among the few that hiked aggressively during the Fed hike cycle last year. With real rates still high, there is room for BI to cut.

Growth impact might be limited this year

Similar with Powell, Governor Perry concern seems to have tilted more towards dimming global conditions and further downside impact of trade war. Especially when real sectors high frequencies indicators such as cement, retail and motor vehicle sales are heading south.

One point of caution, the transmission to growth could be hindered by limitation of the interest-rate channel of monetary transmission to support credit. Lending interest rate has been relatively unchanged last year during the 175bps rate hike. Hence there will be less space to go down this year and next, limiting the transmission of policy rate to credit and growth.

Indonesia Rates

While Bank Indonesia (BI) has been cautious in responding to the Fed pivot at the start of the year, the rally in government bonds suggests that market participants are increasingly comfortable with the idea of looser monetary policy. Notably, 10Y yields have pulled back from this year’s high of 8% and are now trading much closer to the 7% handle.

Measures of short-term liquidity have also improved. The spread of the 3M Jibor over the 7D repo rate has fallen to 65bps (a lifetime-low, given that the 7D repo was introduced in 2016). Instruments that are sensitive to sentiment (USD/IDR and its NDF counterparts) are also flashing green.

We reckon that BI will be prudent relative to peers (India, Philippines and Malaysia have already cut this year) given persistent worries about the current account deficit. Without an improvement in the trade balance (which requires a bounce in commodity prices), the pace and magnitude of rate cuts would likely match that of the Fed (2-3 insurance cuts). Despite the sizable rally, Indo govvies still screen well in our Asia Rates Valuation Indicator. In a world where yield is scarce, the high real and nominal yields offered by Indo govvies will prove irresistible, in our view.

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Masyita Crystallin, Ph.D.

Economist – Indonesia & Philippines

Eugene Leow

Rates Strategist - G3 & Asia


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