In line with our expectation, the central bank of Indonesia (Bank Indonesia) raised its benchmark interest rate (BI 7-Day Reverse Repo Rate) by 25 basis points (bps) to 4.50 percent at the monetary policy meeting in May 2018 that was concluded today (17/05). Agus Martowardojo, Governor of Bank Indonesia, added that the deposit facility and lending facility were raised to 3.75 percent and 5.25 percent, respectively.
Through the interest rate hike Bank Indonesia aims to strengthen the nation's economic stability amid continued uncertainty (and subsequent volatile movements) in global financial markets. Indonesia is among the emerging markets that are plagued the most by capital outflows. Thus, Indonesian stocks, rupiah and bonds have been under heavy pressure in recent weeks.
External pressures stem from the rising US treasury yield, looming further monetary tightening by the US Federal Reserve, rising crude oil prices, concerns about the break out of a global trade war (led by the USA and China), and concerns about stability on the Korean peninsula.
Meanwhile, domestic issues that impact negatively on investor appetite include Indonesia's wider Q1-2018 current account deficit, an unexpectedly large monthly trade deficit in April 2018, and a series of terrorist attacks over the past couple of days.
In theory a higher benchmark interest rate will make Indonesian bonds and the rupiah more attractive and stronger. Meanwhile, theory also teaches us that stocks tend to react negatively (with the exception of those in the banking sector) to a rate hike. However, given the steep decline of Indonesian stocks over the past couple of weeks, investors may decide it is a great time to go bargain hunting. Especially for long-term investors it is now very attractive to enter the Indonesian stock market.