The existing BI rate has been unable to push lending rates down significantly, even though Indonesia's central bank cut its reference BI rate by 75 basis points from 7.50 percent to 6.75 percent (gradually) in the first three policy meetings of 2016. The reverse repo, on the other hand, is regarded a suitable instrument to regulate the expansion and contraction of liquidity in Indonesia's financial markets as this tool is transactional and closely tied to the money market. Repurchase agreements (or repos) are a money-market instrument used to raise short-term capital. Several countries - including Sweden and South Korea - use such a repo as their key monetary tool.

Indonesia's new benchmark will become effective on 19 Augustus 2016. Until that date the central bank will continue to use the existing BI rate. Whether the reverse repo will be maintained at 5.50 percent (in the central bank's last auction) after 19 August remains unknown and depends on macroeconomic developments.

Besides the failure to push down the country's lending rates, Indonesian Chief Economics Minister (and former Bank Indonesia Governor) Darmin Nasution said the existing BI rate also failed to reflect Indonesia's inflation rate. Whereas inflation was at 3.35 percent (y/y) in 2015, the BI rate was 7.50 percent at end-2015, a very wide gap.

Bank Indonesia Governor Martowardojo said it is currently the right time to implement a new benchmark monetary tool that contributes to a deepening of Indonesia's inter-bank market and is to better guide the money market rates from overnight to 12-month tenure. The timing is considered correct because both inflation and the current account balance have experienced an improvement over the past year and are under control.

The new benchmark does not imply monetary easing but should merely be seen as an effort of Bank Indonesia to enhance efficiency and effectiveness of its monetary policy. The new reference rate should lead to lower lending rates and falling net interest margins of Indonesian banks. As such, shares of locally-listed banks may feel temporary selling pressure.

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