On September 22, 2016, the central bank of Indonesia (Bank Indonesia) decided to cut its BI seven-day repo rate from 5.25 percent to 5.00 percent, and this has changed parts of the long-term outlook for investors. Bank Indonesia also reduced its lending rate to 5.75 percent (from previous 5.50 percent), and the deposit rate to 4.50 percent (from previous 4.75 percent previously). This is significant because it shows that lending rates and interest rates have dropped to multi-year lows with the current policy changes.
Though Indonesia’s inflation rate fell to multi-year low of 2.79 percent in August 2016 (from the previous 3.21 percent), its GDP has seen a rise of 4.02 percent in second quarter. Rising textile production and the nation’s currency have helped Indonesia contain its current account deficit within manageable levels. Additionally, the lower inflation rate and the contained deficit have enabled the bank to cut its policy rates. This is a strong positively for earnings in regional companies and their related stock prices.
Chart View: Indonesian Consumer Inflation
The policy statement released by the bank also indicates that there is going to be limited action on monetary policy for the remainder of the year, and the current easing will help the country to gain momentum in economic activity. Though the bank expects that global uncertainty will have an adverse impact on exports, and this could bring unforeseen negatives.
In the statement, the bank has also projected a GDP growth of between 4.9 percent and 5.3 percent for the current year. The bank remained dovish with the expectation that inflation will reach near the target of 4 percent (plus or minus 1 percent) by the end of the year. Gaps created by the tax amnesty scheme in revenue collection will need to be offset by reduced expenditures in order to control the fiscal deficit. This would likely reduce government spending and aggravate some of the country’s stalling economic conditions.
Overall, the widening trade surplus and waning business spending will continue to limit the upward rate revisions, but the rise in manufacturing PMI and increased consumer spending will act as a deterrent to further downward trends in rates. But the trends in inflation show a multi-year low, and this has the potential to act as a catalyst to further rate cuts in 2017.
This column was written by Richard Cox, university teacher in international trade and finance, focusing on lessons in macroeconomics and price behavior in equity markets.