Bank Indonesia Kept 7-Day Reverse Repo Rate at 5.25%; Analysis
Bank Indonesia decided to hold the BI 7-day Reverse Repo Rate at 5.25 percent during the July 2018 monthly policy meeting. It also maintained the deposit facility and lending facility rates at 4.50 percent and 6.00 percent, respectively. Bank Indonesia believes the rates are consistent with its efforts to maintain domestic financial market attractiveness against a backdrop of pervasive uncertainty on global financial markets.
In May and June Bank Indonesia had already raised its benchmark interest rate from 4.25 percent to 5.25 percent in an effort to stabilize the Indonesian rupiah which had become under severe pressure since February 2018. These pressures mainly originate from abroad (looming further rates hikes in the USA as well as concerns over global trade tensions).
Meanwhile, the Indonesian central bank stated that it believes recent macroprudential policy easing measures are able to increase liquidity management flexibility as well as banking intermediation for economic growth. Bank Indonesia is probably referring to the lower down-payment regulations in the property sector (last month it relaxed the loan-to-value ratio in this sector).
Bank Indonesia said it also wants to enhance coordination with the government to safeguard structural reforms, particularly those aimed at reducing the current account deficit, including boosting foreign exchange receipts from tourism and private sector infrastructure financing.
Global Economy & External Influences
Uncertainty in global financial markets remains high, amid uneven world economic growth dynamics. Bank Indonesia expects to see accelerating economic growth in the USA coupled with growing inflation. Meanwhile, economic growth in the European Union (EU) is expected to be weaker than previously predicted.
China's economic growth is not yet improving. In fact, it is still showing a slowing growth trend with a GDP growth pace of 6.7 percent year-on-year (y/y) in the second quarter of 2018.
These global economic dynamics prompted a slowdown in the growth of the world's trade volume and commodity prices. With inflation increasing, the US Federal Reserve is forecast to continue hiking the Fed Funds Rate (FFR) gradually.
Meanwhile, US-China trade tensions elevate risks in global financial markets and the sustainability of global economic recovery. Developments in the global economy prompted US dollar appreciation against nearly all currencies worldwide, including the Indonesian rupiah. High uncertainty in global financial markets has also resulted in capital reversal from emerging markets, including Indonesia.
Bank Indonesia sees the economic growth momentum at home continuing to build in the second quarter of 2018 on the back of strong domestic demand. Household consumption was supported by fiscal stimuli, higher incomes, controlled inflation and growing consumer confidence amongst the middle and upper classes. Solid investment is expected to endure, not only supported by infrastructure projects but also non-infrastructure projects through building and non-building investment.
Strong domestic demand has edged up import growth, particularly imports of capital goods such as transportation equipment, machinery, equipment and spare parts. Meanwhile, export growth is lower than previously predicted due to sliding global commodity prices. The weaker position of net exports has affected the domestic economic growth outlook for 2018, which is approaching the lower end of the 5.1 - 5.5 percent range.
Trade Balance of Indonesia
Indonesia's trade balance recorded a big surplus in June 2018, reinforced by a non-oil & gas trade surplus coupled with a narrower oil & gas trade deficit. The non-oil & gas trade surplus stemmed from fewer imports of machinery and mechanical appliances, electrical machinery and equipment, iron and steel, plastics and plastic products as well as organic chemicals.
On the other hand, the oil & gas trade deficit narrowed as non-oil & gas exports surged and non-oil & gas imports declined. Consequently, the trade balance overcame a USD $1.5 billion deficit in May 2018 by recording a USD $1.7 billion surplus in June 2018.
The June trade surplus has alleviated pressures on the current account deficit, which is predicted to expand in the second quarter of 2018. Indonesia's current account deficit in full-year 2018 is estimated to remain within an acceptable threshold of 3 percent of GDP. Therefore, the position of foreign exchange reserves stood at USD $119.8 billion in June 2018, equivalent to 7.2 months of imports or 6.9 months of imports and servicing of government external debt, which is well above the international standard of three months.
Performance of the Indonesian Rupiah
The Indonesian rupiah experienced depreciatory pressures against broad US dollar appreciation. The rupiah strengthened at the beginning of July 2018 in response to Bank Indonesia's pre-emptive, front-loading and ahead-of-the-curve monetary policy measures (referring to the 50 basis points rate hike in late-June). The favorable market response drew non-resident capital inflows into the domestic financial markets, especially tradeable government securities (SBN), thus prompting rupiah appreciation.
However, pressures on the Indonesian rupiah re-emerged as uncertainty heightened in global financial markets, triggering broad-based US dollar appreciation. On 18 July 2018, the rupiah stood at IDR 14,405 per US dollar, down 0.52 percent on the level recorded at the end of June 2018. Consequently, the rupiah has depreciated by 5.81 percent year-to-date, less severe than currency weakening that is reported in other developing economies, including the Philippines, India, South Africa, Brazil and Turkey.
Indonesian Rupiah versus US Dollar (JISDOR):| Source: Bank Indonesia
Moving forward, Bank Indonesia will remain vigilant of risks related to global financial market uncertainty, while maintaining the rupiah exchange rate in line with the currency's fundamental value. Bank Indonesia continues to support the rupiah through double intervention (purchasing bonds on the secondary market and selling part of its foreign exchange assets).
Consumer Price Index of Indonesia
Inflation remains under control in Indonesia on the back of stable supply. Consumer price index (CPI) inflation was recorded at 0.59 percent month-to-month (m/m) in June 2018, up from 0.21 percent (m/m) in the preceding month. The increase stemmed from the seasonal spike in demand during the Ramadan and Eid-ul-Fitr celebrations. Despite accelerating, Indonesian inflation in June 2018 was below the historic average during Eid-ul-Fitr over the past four years (at an average of 0.81 percent m/m). Annually, therefore, headline inflation eased from 3.23 percent (y/y) to 3.12 percent (y/y) in June.
Controlled inflation was backed by Indonesia's stable core inflation in line with Bank Indonesia's consistent policies to anchor rational inflation expectations, including efforts to maintain the rupiah exchange rate in line with the currency's fundamental value. Moreover, inflationary pressures on volatile foods (VF) were lower than the corresponding historical average during Eid-ul-Fitr due to adequate supplies. Conversely, inflation of administered prices (AP) increased, induced by rising airfares and intercity rates as demand increased during the Eid-ul-Fitr period when millions of city people travel back to their places of origin to spend a couple of days with their families (a local tradition called mudik).
Bank Indonesia's inflation in full-year 2018 is predicted to be around the midpoint of the 3.5±1 percent (y/y) target corridor. Furthermore, policy coordination between Bank Indonesia and the central government and regional administrations will be strengthened in terms of controlling inflation.
Financial System Stability Indonesia
Indonesia's financial system remains stable and the bank intermediation function is improving, while non-bank financing continues to expand. Maintained financial system stability is reflected by the high capital adequacy ratio (CAR) at 22.1 percent in the banking industry and the liquidity ratio of 20.3 percent in May 2018. In addition, the banking industry maintained a low level of non-performing loans (NPL) at 2.79 percent (gross) or 1.28 percent (net).
Financial system stability is also contributing to improvements in the bank intermediation function. Deposit growth declined from 8.1 percent (y/y) to 6.5 percent (y/y). Bank Indonesia believes that the decline will not hamper credit growth, considering the ample bank liquidity to support financing. Credit growth accelerated from 8.9 percent (y/y) to 10.3 percent (y/y) in May 2018.
On the other hand, non-bank economic financing through the financial markets, such as initial public offerings (IPO) and rights issues, corporate bonds, medium-term notes (MTN) and Negotiable Certificates of Deposit (NCD), soared 60.2 percent (y/y) in May 2018. Based on the recent domestic economic gains and progress in terms of banking industry and corporate consolidation, Bank Indonesia projects stronger credit and deposit growth in 2018 at 10-12 percent (y/y) and 9-11 percent (y/y), respectively.
Higher banking intermediation is also supported by a number of relaxations in Bank Indonesia's macroprudential policy, through the easing of the loan-to-value (LTV) ratio and the implementation of Macroprudential Intermediation Ratio, Macroprudential Liquidity Buffer, and Average Reserve Requirement policies.