Although the business community in Indonesia requests that the country’s benchmark interest rate (BI rate) is lowered at Bank Indonesia’s next Board of Governor’s Meeting (scheduled for Thursday 12 June 2014), it is highly unlikely that the central bank will alter its BI rate which currently stands at 7.50 percent. The relatively high BI rate curbs business expansion and therefore limits higher economic expansion in Indonesia. However, several factors justify the continuation of the BI rate at 7.50 percent.
Mirza Adityaswara, Senior Deputy Governor at Bank Indonesia, said that the BI rate will probably be kept at 7.50 percent up to the third quarter of 2014 as Indonesia faces a number of economic challenges that can destabilize the domestic economy if not dealt with carefully. Perhaps the largest challenge is to curb the country’s wide current account deficit. In the first quarter of 2014, Indonesia recorded a current account deficit of USD $4.19 billion, equivalent to 2.06 percent of GDP. However, this deficit is expected to widen in the second and third quarters of 2014. Recently, Bank Indonesia Governor Agus Martowardojo said that the current account deficit may double in the second quarter of 2014 after seeing the country’s trade deficit in April 2014 rise to USD $1.96 billion (mainly due to a sharp decline of crude palm oil and other vegetable oil export).
In 2013, the current account deficit stood at USD $29.09 billion, or 3.33 percent of GDP. The structural cause of this deficit is that the growth of demand in Indonesia (for a wide variety of products or goods, for example mobile phones and particularly expensive oil) outpaces growth of domestic production, thus resulting in the increasing need for imports. In the second and third quarters the deficit is expected to widen as many companies will engage in business expansion, thereby fuelling the need for imports. These companies will need more imports of oil & gas as well as raw materials, machinery and other equipment.
One way to curb imports is through a tightening of monetary policy, for example by keeping the BI rate high, thus sacrificing higher economic growth for economic stability.
Standard Chartered Bank economist Eric Sugandi also believes that the BI rate needs to be maintained because if Bank Indonesia alters the rate, then Indonesia will experience more economic costs than benefits due to a further weakening Indonesian rupiah exchange rate, higher inflation as well as outflows of foreign capital.
Morgan Stanley labelled Indonesia as one of the fragile five due to Indonesia’s reliance on overseas debt to pay for imports. The last year in which Indonesia recorded a current account surplus was in 2011 (0.2 percent of GDP).
Current Account Balance of Indonesia: