Bank Indonesia Cut Policy Rate in Support of Economic Recovery
For the first time since October 2016, the central bank of Indonesia (Bank Indonesia) altered its benchmark BI 7-day (Reverse) Repo Rate. After a nine-month hiatus the lender of last resort resumed monetary easing through cutting the benchmark by 25 basis points to 4.50 percent at the August 2017 policy meeting. Meanwhile, while the deposit and lending facility rates were also cut by 25 bps to 3.75 percent and 5.25 percent, respectively, effective 23rd August 2017.
The latest move will be followed by a decrease in interest rates on other monetary instruments, a decision that is allowed for amid macroeconomic stability, as evidenced by low inflation with 2017 and 2018 inflation projected within the target range, and the current account deficit being under control within a healthy range.
Meanwhile, external risks, particularly those related to the looming Federal Reserve hike and the unwinding of its balance sheet, have decreased. Hence Indonesia can offer a still-attractive domestic interest rate, compared to the external interest rates. The policy rate easing is expected to reinforce intermediation in the banking sector, strengthen financial system stability as well as support higher economic growth.
Bank Indonesia sees expanding global economic growth, entailed with shifts in sources of growth. On the one hand, solid consumption and expanding exports are driving China's economy, while, in Europe, stronger economic growth is expected on the back of increased consumption and export performance. On the other hand, the flagging US economy is consistent with weaker consumption and investment, subdued by the oil price outlook.
These developments in the global economy could prompt an increase in world trade volumes, while international commodity prices are set to remain high. Meanwhile, the Fed is estimated to raise its Fed Funds Rate (FFR) only once, at the end of 2017, while the US balance sheet normalization is expected to be announced in September 2017.
Indonesia's economic growth in the second quarter of 2017 was recorded at 5.01 percent (y/y), lower than expected. Growth was supported by investment gains, particularly building investment in line with the acceleration of government infrastructure expenditure and rising private investment projects.
On the other hand, household consumption growth slowed in Q2-2017, while government consumption contracted after spending was delayed. Externally, exports posted slower growth due to the tepid global economic recovery, which triggering a decline in manufacturing export volume. Spatially, slow exports were mainly reported on the islands of Java, Sulawesi and Kalimantan, resulting in slower growth in these regions.
Regarding the remainder of 2017, Bank Indonesia expects Indonesia's economic growth to improve on the back of increased investment and consumption activities, in line with more expansive government spending and additional room to ease monetary policy. The central bank held its growth targets in the ranger of 5.0 - 5.4 percent (y/y) for 2017 and 5.1 - 5.5 percent (y/y) for 2018.
Indonesia's balance of payments (BoP) recorded a surplus, while the current account deficit remained well maintained and financed by a large surplus in the capital and financial account. In the second quarter of 2017, the BoP recorded a USD $0.7 billion surplus, supported by the USD $5.9 billion surplus in the capital and financial account, well over the current account deficit of USD $5.0 billion (equivalent to 1.96 percent of GDP). The position of Indonesia's foreign reserve assets at the end of July 2017 was recorded at USD $127.8 billion, equivalent to 9.0 months of imports or 8.7 months of imports and servicing government external debt, which is well above the international adequacy standard of three months.
Moving forward, Bank Indonesia expects the BoP performance to remain in surplus throughout 2017 and 2018. The current account deficit is expected to remain within a healthy range of under 3 percent of GDP, namely 1.5 - 2.0 percent of GDP in 2017 and 2.0 - 2.5 percent in 2018.
The rupiah remained relatively stable, supported by high confidence in Indonesia's macroeconomic stability. The rupiah appreciated by an average of 0.30 percent to IDR 13,309 per US dollar in the second quarter of 2017. Rupiah exchange rate stability was supported by the influx of foreign capital along with the prospect of positive returns, followed by the abundant supply of corporate foreign exchange on the domestic forex market. Bank Indonesia expects the rupiah to remain stable.
Indonesian Rupiah vs US Dollar (JISDOR):| Source: Bank Indonesia
Indonesian nflation was kept at a lower-than-expected rate and therefore Bank Indonesia is confident it will fall within its 3 - 5 percent (y/y) target range at the end of 2017, and 2.5 - 4.5 percent (y/y) in 2018. CPI inflation was recorded at 2.60 percent (ytd) in July 2017 or 3.88 percent (y/y) annually. In addition to the controlled administered prices inflation, volatile foods inflation and core inflation were recorded lower than the average post-Idul Fitri rate for the past three years. Annually, low core inflation was recorded at 3.05 percent (y/y), along with limited domestic demand, maintained inflation expectation, and stable exchange rate.
Lastly, banking industry resilience and stable financial markets continued to strengthen financial system stability in Indonesia. In June 2017, the capital adequacy ratio (CAR) of the banking industry was recorded at 22.5 percent and the liquidity ratio at 21.2 percent. Meanwhile, non-performing loans (NPL) stood at 3.0 percent (gross) or 1.4 percent (net). The banking industry confirmed that deposit growth decelerated from 11.2 percent (y/y) in May 2017 to 10.3 percent (y/y) in June 2017, while loan growth slowed from 8.7 percent (y/y) in May 2017 to 7.8 percent (y/y) in June 2017. At the end of 2017, deposit growth is expected to be in the range of 9 - 11 percent, while credit growth is estimated to be lower than previously expected, in the range of 8 - 10 percent. Banking intermediation is expected to improve in 2018 with credit and deposit growth expected at 10 - 12 percent and 9 - 11 percent, respectively.