In line with expectations Indonesia's central bank (Bank Indonesia) kept its benchmark reference rate - the BI 7-Day (Reverse) Repo Rate - at 4.75 percent at Thursday's policy meeting (17/11). This decision was made amid the high degree of uncertainty in global financial markets (triggered by the 2016 US presidential election) and stable domestic conditions (low inflation and an improving current account deficit). The high degree of volatility does cause major pressures on the rupiah and therefore Bank Indonesia will continue to stabilize exchange rates through intervention in markets.
Bank Indonesia expects the global economic recovery to persist, albeit slowly, but commodity prices have begun rebounding. Amid aforementioned global uncertainty following Donald Trump's victory in the US election, the US economy has shown signs of recovery, reflected by GDP growth, stable unemployment and rising inflation. Consequently, the chance of a Federal Funds Rate (FFR) hike in December 2016 has increased. However, limited economic growth is expected in other advanced economies, including the European Union (EU), overshadowed by political risks.
In contrast, developing countries such as China and India are predicted to continue to drive the global economy. On the commodity markets, the global oil price remains low due to high OPEC production, while several major exports from Indonesia have seen their prices improve, including crude palm oil (CPO), coal, and various mining products. In a statement, Bank Indonesia said it will continue to monitor the progress of transitions in the US Government as well as future US policies, especially those relating to fiscal, policy rate and international trade.
The economy of Indonesia continued to perform soundly supported by strong household demand. GDP growth was recorded at 5.02 percent (y/y) in the third quarter of 2016. In terms of investment, growth in construction was solid amid ongoing government-led infrastructure project development. But private investment remains subdued, especially in the non-contruction sector, amid fiscal consolidation that pushed government consumption into negative territory.
Regionally, robust economic growth was achieved on the islands of Java and Sumatra, while growth in Eastern Indonesia accelerated as mining exports surged and more smelters began operating. By sector, Indonesia's manufacturing industry, agriculture and trade recorded positive growth. Bank Indonesia sees more muted growth in the last quarter of the year, in line with fiscal consolidation, at around 5 percent (y/y). In 2017, however, the economy is projected to expand in the range of 5.0 - 5.4 percent.
Indonesia’s balance of payments (BOP) recorded a larger surplus in the third quarter of 2016, supported by a narrower current account deficit combined with a growing capital and financial account surplus. The BOP surplus stood at USD $5.7 billion, increasing significantly from USD $2.2 billion last quarter. Such conditions are indicative of greater external balance and further bolster macroeconomic stability. The current account deficit was observed to narrow from USD $5.0 billion (2.2 percent of GDP) in the second quarter to USD $4.5 billion (1.8 percent of GDP) in the third quarter of 2016. A larger non-oil and gas trade surplus due to rising export prices, coupled with fewer oil and gas imports as well as a narrower oil and gas deficit as gas exports increased, contributed to the reduction. In addition, the services account deficit also decreased due to a growing travel services account surplus in the reporting period. On the other hand, the capital and financial account surplus increased from USD $7.6 billion to USD $9.4 billion over the same period, buoyed by positive sentiment concerning the promising domestic economic outlook. Consequently, the position of official reserve assets at the end of October 2016 stood at USD $115.0 billion, equivalent to 8.4 months of imports and servicing government external debt.
The Indonesian rupiah continued to appreciate in the third quarter, on positive domestic and external sentiment, before coming under heavy pressure in November following Trump's victory in the US election. On average, the rupiah appreciated 1.39 percent to close at a level of IDR 13,130 per USD. Additionally, rupiah gains persisted into October 2016, strengthening a further 0.71 percent to IDR 13,048. Rupiah appreciation stemmed from positive sentiments surrounding the solid domestic economic outlook, in line with maintained macroeconomic stability and successful implementation of the tax amnesty program.
Indonesian Rupiah versus US Dollar (JISDOR):| Source: Bank Indonesia
Externally, however, the rupiah strengthened as global risks eased on the back of clearer policy direction from the Federal Reserve concerning the next FFR hike. However, from the 1st to 16th of November, the rupiah depreciated by an average of 2.53 percent to IDR 13,378 per USD as uncertainty reappeared after the US election. Nevertheless, Bank Indonesia notes that pressures on the rupiah were relatively limited compared to currencies of other emerging market economies. Consequently, the rupiah has appreciated by 2.97 percent so far this year. Moving forward, Bank Indonesia says it will continue to stabilize exchange rates in line with the rupiah’s fundamental value by maintaining market mechanisms.
Inflation remains under control and is predicted to reach around 3.0 - 3.2 percent (y/y). The Consumer Price Index recorded inflation of 0.14 percent (m/m) or 3.31 percent (y/y) annually. Administered prices were the main contributor to inflation, led by rising electricity rates, household fuel prices, rail tickets and cigarette prices. In contrast, core inflation was recorded at 0.10 percent (m/m) or 3.08 percent (y/y) in line with limited domestic demand, anchored inflation expectations and rupiah appreciation. On the other hand, volatile foods (VF) experienced deflation due to price corrections affecting several foodstuffs.
Financial system stability was maintained along with banking system resilience. At the end of the third quarter of 2016, the Capital Adequacy Ratio (CAR) stood at 22.3 percent and the liquidity ratio (liquid assets/deposits) at 20.2 percent. Meanwhile, non-performing loans (NPL) were low and stable at 3.1 percent (gross) or 1.4 percent (net). The looser monetary policy stance up to September has successfully transmitted through the interest rate channel, as reflected by lower deposit rate (by 108 bps, ytd) and lending rate (by 60 bps, ytd).
In contrast, however, monetary policy transmission through the credit channel remains suboptimal, in line with limited demand, including investment from the corporate sector. Credit growth was recorded at 6.5 percent (y/y) in Q3, decelerating from 7.9 percent (y/y) last period. Meanwhile, transmission through the capital market, including issuances of shares, bonds and medium-term notes (MTN), accelerated. Deposit growth stood at 3.2 percent (y/y), slowing down from 5.9 percent (y/y) in the previous quarter. The slowdown is estimated to be transient, associated with the implementation of tax amnesty law, and will bounce back at the end of year. Bank Indonesia believes that the transmission of looser monetary and macroprudential policies will continue and, therefore, boost credit and other financing growth to support stronger economic growth moving forward.
Bank Indonesia (additional information by Indonesia Investments)