Bank Indonesia Governor Agus Martowardojo stated that the central bank saw more room to ease monetary policy because inflation has been under control at slightly above 3 percent (y/y) and there are no signs of inflationary shocks for the remainder of the year. Moreover, Indonesia's current account deficit has been improving (expected to fall below 2 percent of the country's gross domestic product (GDP), the trade budget surplus exceeds expectations, while Indonesia's rupiah exchange rate remained stable. This all provides the right domestic context to cut interest rates and encourage credit expansion as well as economic growth. So far this year credit growth has been weak (in August 2016 credit growth expanded by 6.8 percent (y/y), decelerating from 7.7 percent (y/y) in the preceding month, and the weakest growth rate since November 2009.

Another factor that allowed for a looser monetary policy in Indonesia is fading concerns about a sooner-than-expected interest rate hike in the USA. Executive Director at the Economic and Monetary Policy Department of Bank Indonesia Juda Agung said he expects the Fed Funds Rate rising once before the year-end (possibly December). However, he does not believe this move will have a big impact on global markets as the hike should be priced in already.

Lower interest rates in Indonesia imply that domestic demand, including credit demand, will strengthen. This is important as Indonesia cannot count on much support from the global economy, especially as China - one of Indonesia's biggest trading partners - remains in slowdown-mode. In full-year 2016 Indonesia's central bank eyes economic growth in the range of 4.9 percent to 5.3 percent.

In a statement released on its website, Bank Indonesia informed that it expects Indonesia's economic growth to ease in the third quarter of 2016. Although consumption improves slightly, private investment, particularly non-construction investment, is estimated to remain weak in line with the large installed production capacity. Moreover, the government's decision to cut public spending in the remainder of 2016 will also limit room for economic growth in 2016.

Read more: Analysis Performance & Accomplishments Indonesia Under Jokowi

The interest rate cut in October was the sixth time already that Bank Indonesia eased monetary policy in 2016. At the year-start the key interest rate still stood at 7.50 percent. However, after six interest rate cuts (and the change from the 12-month BI rate to the 7-day reverse repurchase rate in August 2016) the nation's key rate is now at 4.75 percent.

Bank Indonesia Benchmark Interest Rate:

The latest cut was a surprise as most analysts had forecast Bank Indonesia to maintain its interest rate regime ahead of the year-end when the US Federal Reserve might decide to raise its key Fed Funds Rate. It remains unclear whether this move would give rise to capital outflows from emerging market economies, including Indonesia, or will be ignored by markets as it has been priced in already.

Benchmark Interest Rates Across the Globe::

Country Key Rate
Indonesia     4.75
United States     0.50
Singapore     0.12
Thailand     1.50
China     4.35
Malaysia     3.00
Japan    -0.10
European Union     0.00
South Korea     1.25

Source: Investor Daily