Bank Indonesia May Keep Key Rate at 4.75% throughout 2017
Bank Indonesia, the central bank of Indonesia, is expected to maintain its benchmark interest rate (the seven-day reverse repurchase rate, or reverse repo) at 4.75 percent in the remainder of 2017. Priasto Aji, economist at the Asian Development Bank (ADB), says Bank Indonesia may not need to adjust its key interest rate at all this year even though there is looming further monetary tightening in the USA.
Monetary tightening in the USA tends to trigger capital outflows from emerging markets, including Indonesia. With the Federal Reserve seemingly committed to conduct two more interest rates in 2017, there is a risk of seeing pressure on Indonesian stocks and the rupiah around the days of a US rate hike (pressure on the rupiah can be counterbalanced if Bank Indonesia also raises its key interest rate). However, in the last US rate hike (March 2017) the Fed communicated its intentions clearly to the market and this was the main reason why the rate hike was priced in and therefore did not impact drastically on Indonesian assets (in fact there was room for capital inflows into Indonesia after the Fed's latest rate hike although this phenomena was primarily due to the Fed's more dovish-than-previously-anticipated accompanying statements).
The same context is expected to occur in the coming US rate hikes, most likely later this year. Only a sudden very hawkish attitude of the Fed could destabilize markets. However, since the Fed has been communicating its intentions clearly and gradually in order to avoid such shocks we expect the Fed will not allow major shocks such as we saw in 2013 (taper tantrum).
ADB economist Aji adds Indonesia's domestic situation is stable and would therefore not require a rate hike. Indonesia's inflation rate is relatively low and should stay within Bank Indonesia's target range of 3 - 5 percent (y/y) in the remainder of 2017. Meanwhile, the Indonesian rupiah has been stable against the US dollar since late 2015, while Indonesia's current account deficit is also in a better shape now compared to several years ago.
Another positive matter is that Indonesia's foreign exchange reserves have been on the rise over the past couple of months. In late-March 2017 they stood at USD $121.8 billion. Although this is small compared to forex assets in other regional countries, for Indonesia the present level means it is approaching its record high level (USD $124.6 billion in August 2011). Rising foreign exchange assets imply the central bank has more ammunition to minimize currency volatility.
However, there remain some global issues that can destabilize markets. Although the election in the Netherlands showed that there was less-than-expected support for right-wing and anti-European Union political parties, markets will be carefully watching the French and German elections later this year. If results are not in line with investors' expectation then these elections could cause financial market turbulence that may require a rate hike in Indonesia. But for now we assume to see the same scenario as in the Dutch election a month ago.