In recent months Bank Indonesia has repeatedly stated that the rupiah, which has depreciated 16 percent against the US dollar so far in 2015, is undervalued and therefore it has been intervening heavily in the foreign exchange and bond markets to stabilize the currency. Besides safeguarding rupiah stability, the central bank also indicated that controlled inflation is a key driver of its monetary policy direction. With the current fragile state of the rupiah as well as high inflation (7.18 percent y/y in August, well above Bank Indonesia’s full-year 2015 target of 3-5 percent), this would mean that an interest rate hike is more likely to occur than an interest rate cut. Currently, the benchmark interest rate (BI rate) is already relatively high at 7.50 percent.

Benchmark Interest Rate Bank Indonesia (BI Rate):

However, it is also assumed that Bank Indonesia will try not to raise its key BI rate as it would drag down economic growth of Southeast Asia’s largest economy. In the second quarter of 2015, Indonesia’s GDP growth fell to a six-year low of 4.67 percent (y/y) and - besides heavy external pressures - the relatively high BI rate was also partly behind this slowdown as credit expansion was curbed. After inflation spiked due to higher subsidized fuel prices in mid-2013, Bank Indonesia gradually (yet aggressively) raised its BI rate from 5.75 percent in June 2013 to 7.50 percent in November 2013 and it has stayed high ever since. Over the past year, several government officials (including Vice President Jusuf Kalla) and businesses have requested the central bank to cut its rate. However, such requests fell on deaf ears. Instead, Bank Indonesia used other tools to try to boost the economy (for example by introducing lower down payment requirements for the purchase of property and vehicles).

A Reuters poll, involving 18 economists, indicates that Bank Indonesia will most likely not alter its benchmark interest rate today as pressures on the currency and bond markets of Indonesia have risen ahead of the looming Fed Fund Rate hike. Today, Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) hit a fresh 17-year low at IDR 14,452 per US dollar, while the benchmark 10-year sovereign bond yield rose to 9.462 percent, the highest since January 2011.

Indonesian Rupiah versus US Dollar (JISDOR):

| Source: Bank Indonesia

The whole world is currently watching the ongoing policy meeting of the Federal Reserve. Whether the US central bank will raise its Fed Fund Rate (for the first time since 2006) at this occasion remains a big question as recent US macroeconomic data are mixed, while a rate hike would make the US dollar even stronger (hence impacting negatively on the export performance of the USA thus jeopardizing its economic recovery). Moreover, recent global concern about China’s hard landing will also make the Fed think twice before hiking its rate.