Bank Indonesia Holds Rates; Sees Stable Economy & Recovery
The central bank of Indonesia (Bank Indonesia) kept its benchmark interest rate - the BI 7-day Reverse Repo Rate - at 4.25 percent at the February Board of Governor's Meeting (14-15 February 2018). Meanwhile, it maintained the deposit facility and lending facility rates at 3.50 percent and 5.00 percent, respectively (effective per 19 February 2018).
The present interest rate regime is regarded the right one to maintain macroeconomic and financial system stability, while supporting the domestic economic recovery, Bank Indonesia noted in a statement. The central bank believes its earlier rounds of monetary easing are adequate in terms of building domestic economic recovery momentum. Economic stability is regarded the backbone of stronger and more sustainable economic growth for Southeast Asia's largest economy.
Bank Indonesia sees several risks, including global risks, that can impact negatively on the Indonesian economy. These include growing uncertainty in the global financial markets due to the anticipation of a higher-than-expected Fed Funds Rate (FFR) hike, coupled with the rising crude oil price. Domestic risks stem from ongoing corporate consolidation, a sluggish bank intermediation function and the inflation risk.
Global economic growth is expected to accelerate this year, accompanied by rising international commodity prices. Stronger-than-expected economic gains in advanced and developing economies push global economic growth higher. Regarding the advanced economies, growing investment and consumption on the back of recent tax reforms will boost the US economy. Consequently, more FFR hikes are believed to be undertaken this year along with the unwinding of the Federal Reserve's balance sheet in response to rising US inflation, approaching the Fed's target corridor.
The economy of the European Union (EU) is projected to accelerate on the back of improving exports and growing consumption and accommodative monetary policy. Furthermore, growth projections in Japan have been revised upwards on robust exports, tax incentives for the corporate sector and accommodative monetary policy. Regarding the developing economies, solid economic growth in China is expected to persist as increasing demand, particularly from advanced countries, drives exports. Meanwhile, India's economy is starting to thrive as the effects of demonetisation and the implementation of the new tax system fade. Consequently, the promising global economic outlook will boost world trade volumes and elevate international commodity prices, including the crude oil price, in 2018.
The Indonesian economy continued to show signs of improvement. Actual gross domestic product (GDP) growth reached 5.19 percent year-on-year (y/y) in the fourth quarter of 2017, up from 5.06 percent (y/y) in the previous quarter, which is indicative of maintained domestic economic recovery momentum. Solid economic growth is supported by a stronger structure, with investment and exports cited as the main drivers. Relatively high investment growth has reached 7.27 percent (y/y), supported by building investment for infrastructure development as well as non-building investment in anticipation of increasing future demand.
Meanwhile, the global economic recovery and rising international commodity prices stimulated Indonesia's export growth to the tune of 8.5 percent (y/y). Furthermore, accelerated government spending and stable household consumption backed by controlled inflation has also catalyzed national economic growth. By sector, the construction sector, transportation and warehousing as well as information and communication are the main contributors to the flourishing domestic recovery. In contrast, the manufacturing industry remains subdued despite strong performance recorded in several sub-sectors, including the food and beverages industry, textiles and clothing as well as base metals. Regionally, the economies of Sulawesi, Maluku and Papua have accelerated, offsetting slower growth in Java, Kalimantan and Bali & Nusa Tenggara and stable growth in Sumatra.
Consequently, national economic growth in 2017 stood at 5.07 percent (y/y), the highest on record for the past four years. In 2018, Bank Indonesia projects the domestic economy to expand in the range of 5.1 - 5.5 percent (y/y), buoyed by investment in ongoing infrastructure projects coupled with rising non-building investment, including private investment, specifically machinery and equipment. In addition, solid export growth is expected to continue as the global economy continues to recover and international commodity prices remain high.
Indonesia's balance of payments (BoP) recorded another surplus, while the current account deficit remained under control. Indonesia's BoP surplus in the fourth quarter of 2017 was underpinned by a significant capital and financial account surplus together with a controlled current account deficit. A surplus of direct investment and portfolio investment bolstered the capital and financial account performance. On the other hand, the current account deficit in the fourth quarter of 2017 was caused by a narrower goods trade surplus and larger services trade deficit. Therefore, the BoP recorded a surplus totaling USD $11.6 billion in 2017, supported by a wider capital and financial account surplus and a reduction in the current account deficit to 1.7 percent of GDP.
This led to an increase in the official reserve assets at the end of December 2017 to USD $130.2 billion. In January 2018, the trade balance recorded a deficit of USD $0.68 billion, albeit followed by relatively high capital inflows. The official reserve assets increased yet again in January 2018 to USD $132.0 billion, representing an all time high for Indonesia. The current position of reserve assets is equivalent to cover 8.5 months of imports or 8.2 months of imports and servicing of government external debt, which is well above the international standard of three months.
Bank Indonesia expects Indonesia's current account deficit in 2018 to remain under control and within a safe threshold at 2.0 - 2.5 percent of GDP in line with domestic economic improvements.
The Indonesian rupiah tended to appreciate in January 2018 after defying pressures in the fourth quarter of 2017. In the last quarter of 2017 the rupiah depreciated by an average of 1.51 percent to IDR 13,537 per US dollar, before rebounding 1.36 percent to IDR 13,378 per US dollar in January 2018 as non-resident capital inflows returned in line with the promising national economic outlook and appreciation of regional currencies. In early February 2018 rising uncertainty in the global financial markets, especially related to a looming higher-than-expected FFR hike has caused pressures in global currencies, including the rupiah.
Indonesian Rupiah versus US Dollar (JISDOR):| Source: Bank Indonesia
Indonesian inflation in January 2018 remained under control and within the target corridor of the central bank. Indonesia's consumer price index (CPI) declined from 0.71 percent month-on-month (m/m) in December 2017 to 0.62 percent (m/m) in January 2018. On an annual basis, CPI inflation stood at 3.25 percent (y/y) in January 2018, which is consistent with the inflation target for 2018 at the range of 2.5 - 4.5 percent. Manageable inflation stemmed from core inflation, which was controlled in line with Bank Indonesia's policy to consistently maintain exchange rate stability and anchor inflation expectations. In addition, administered prices deflation, as transportation tariffs normalized after the holiday season, was also a considerable drag on headline inflation. Nevertheless, inflationary pressures on volatile foods increased as a result of soaring rice prices.
The financial system of Indonesia remained stable despite a sluggish bank intermediation function. Maintained financial system stability is reflected in the high capital adequacy ratio (CAR) in the banking industry, namely 23.0 percent, and a liquidity ratio of 21.5 percent in December 2017. Meanwhile, congruent with efforts to enhance credit risk management in the banking industry, the ratio of non-performing loans (NPL) improved, decreasing to 2.6 percent (gross) or 1.2 percent (net) at the end of 2017. Monetary and macroprudential policy easing was successfully transmitted through the interest rate channel as demonstrated by banks' propensity to reduce deposit and lending rates by 65 basis points (bps) and 74 bps respectively from January - December 2017.
Notwithstanding, transmission through the credit channel remained ineffective due to weak demand for new loans combined with selective bank lending. Credit growth in 2017 was recorded at 8.2 percent (y/y), up from 7.9 percent (y/y) in the preceding year. Despite restrained credit growth, economic financing through the capital market, including initial public offerings (IPO) and rights issues, corporate bond issuances and medium-term notes (MTN), has continued to increase, expanding by 29.8 percent in 2017, in line with the financial deepening program. Meanwhile, deposit growth was recorded at 9.4 percent (y/y) in 2017, down slightly from 9.6 percent (y/y) in 2016. With the expected economic recovery and progress in terms of corporate and banking sector consolidation, Bank Indonesia predicts stronger credit and deposit growth in 2018, improving respectively to 10 - 12 percent (y/y) and 9 - 11 percent (y/y).