The central bank of Indonesia (Bank Indonesia) cut its benchmark BI 7-day Reverse Repo rate (RR rate) by 25 basis points to 5 percent at the policy meeting that was concluded on Thursday (22/09). The lender of last resort also cut the Deposit and Lending Facility rates¹ by 25 basis points to 4.25 percent and 5.75 percent, respectively. Given the stable domestic economy, Bank Indonesia is able to allow a loser monetary policy hence providing more room for accelerated economic growth amid a still uncertain global economic context.
It was the fifth time this year that Bank Indonesia cut its benchmark interest rate and the first time since it adopted the RR rate as benchmark (this rate was adopted at the August 2016 policy meeting). Bank Indonesia stated that the domestic context is stable - with low inflation, an under control current account deficit, and a stable Indonesian rupiah exchange rate - while the US Federal Reserve decided to leave its interest rates unchanged at a policy meeting that took place overnight (a delay in US monetary tightening will most likely result in capital inflows into stable emerging markets such as Indonesia).
Moreover, Bank Indonesia Governor Agus Martowardojo said the central bank still has room to cut rates further before the year-end. However, with a looming Fed Funds Rate - markets are betting on a December rate hike - room for monetary easing in Indonesia should be somewhat limited as a Fed Funds Rate hike should cause a significant amount of capital outflows from emerging markets (although this would be just a temporary phenomenon).
Capital inflows into Indonesia have been strong so far this year as central banks around the globe (USA, Japan and the European Union) have stuck to their ultra lose monetary policies. Up to the end of August a total of USD $11.1 billion went into Indonesian stocks and bonds, exceeding the total amount capital inflows in full-year 2015. With interest rates low in the advanced markets, investors continue to eye more lucrative (higher-yielding), yet riskier assets in emerging markets.
A lower interest rate environment in Indonesia is expected to boost credit growth in Southeast Asia's largest economy as there should emerge a rise both at the demand (particularly the private sector) and supply side. Rising credit growth as a result of business expansion and higher household consumption should boost overall economic growth. So far this year, however, credit growth in Indonesia has been weak.
Recently, expectations about Indonesia's GDP growth for the remainder of 2016 were revised down (toward 5.1 percent) as the government decided to cut IDR 137 trillion from its spending programs that were set in the 2016 Revised State Budget. While public and private investment will remain somewhat bleak, household consumption is expected to remain strong. The lower RR rate decided up on at the September policy meeting should be able to somewhat offset the negative impact of lower public spending. Bank Indonesia set its forecast for Indonesia's economic growth in 2016 in the range of 4.9 - 5.3 percent (y/y).
¹ The overnight Deposit Facility (called Fasbi) is the rate that Bank Indonesia pays to the nation's commercial lenders on the funds that they deposit at Bank Indonesia overnight, while the Lending Facility rate is the rate at which banks can borrow overnight funds from Bank Indonesia.