Searching for Financial Stability: Indonesia's BI Rate Policy Questioned
On Thursday 12 December 2013, Indonesia's central bank (Bank Indonesia) announced that the country's benchmark interest rate (BI rate) remains unchanged at the level of 7.50 percent in December 2013. This announcement was a bit surprizing as about 80 percent of analysts expected Bank Indonesia to raise the BI rate in order to support the depreciating Indonesia rupiah exchange rate. Starting the year at IDR 9,670 per US dollar, the rupiah has fallen around 25 percent to IDR 12,081 per US dollar.
Based on my analysis, Bank Indonesia began to think that another increase in the BI rate will intensify the negative impact on the country's real sector. With the inflation projection for next year relatively low (in the range of 5-6 percent), the increase of the BI rate will only absorb liquidity in the market and thus will disrupt economic growth. But the BI rate itself is not a versatile instrument that can control all matters. Indonesia is currently facing a wide current account deficit due to excessive fuel imports. Of course the BI rate is not an appropriate tool to combat this deficit.
Indonesia's benchmark stock index (IHSG) fell 37.39 points (0.89 percent) to 4,174.83 on Friday (13/12) as foreign funds (IDR 341 billion) left. The rupiah lost 1.3 percent against the US dollar last week, becoming the worst performing currency in Asia. Ahead of the FOMC meeting this week, increased speculation that the Federal Reserve will reduce its stimulus program and the US Congress' agreement to ease USD $63 billion in automatic spending cuts in the next two years have been triggers for the weakening of the rupiah against the US dollar as well as a correction in Indonesia's stock market.
The IHSG will remain vulnerable to pressures, especially in the first quarter of 2014 due to the Fed's tappering as well as legislative and presidential elections in Indonesia. Thus investors will avoid riskier instruments, such as stocks and bonds. Last week's correction of the IHSG was more the consequence of the depreciating rupiah exchange rate. In terms of rupiah stability, Bank Indonesia's policy to maintain its BI rate is no longer effective in controlling the market. The government should do something more tangible to control the trade deficit and foreign currency liquidity. If at the end of the year the rupiah will be at IDR 11,500 per US dollar then the window dressing that will be conducted by fund managers will be able to bring the IHSG to a positive level.
We are now in the last month of 2013. In the past ten years, the IHSG was always up in December, including in the year 2008 when the IHSG experienced a remarkable correction. I am still optimistic that the IHSG will be able to move to a positive level this month.