Bank of Indonesia: Assessing Impact of Sudden Rate Cut
The Bank of Indonesia recently resorted to a sudden cut in interest rate (by 25 bps to 4.75 percent) at its 20th October 2016 meeting. This followed a 25 bps reduction in September and thus this is the sixth time this year that the Indonesian central bank has elected to loosen monetary policy.
Chart View: Indonesia's Benchmark Interest Rate:
Here, it is important to remember that when President Joko Widodo took to office two years ago, the macroeconomic target rate was 7 percent but economic underperformance has led to a significant decrease in the underlying interest rates. There are expectations that the US Federal Reserve could increase rates in December which would further undermine the IDR currency. For Indonesia, Inflation is in the lower band (ranging between 3 to 5 percent) but it is still within controls fundamentally.
Indonesia Inflation Rate:
The seven-day repurchase rate was also lowered from 5 percent to 4.75 percent. This was a policy stance that was adopted by the Bank in August of this year with an objective of adding needed impetus to the economy -- and with it there has been some easing in borrowing costs.
Portfolio Investments: The global uncertainties have made their impact. However, with respect to Indonesia, the economy has yet to feel the brunt. The strong portfolio investments seen in the region tell the story. More investments are impending, and this is something that should help in adding the stability to the economy. Capital inflows of US$12 billion have entered the country in the most recent period, and the Rupiah has strengthened by more than 5 percent over the same stretch of time. Foreign exchange reserves floored in October 2016 from the numbers seen in September.
Indonesia Foreign Exchange Reserves:
Still the Bank is optimistic on the inflow of foreign funds into next year despite the rate hike signals that have already been sent from the Federal Reserve.
In the opinion of the Chief economist of Deutsche Bank, Taimur Baig, the domestic considerations of the Indonesian economy are currently more important than the global considerations that might be made. Emerging economies should not be too concerned with the decisions of the Fed as it has its own progress to make towards the objectives it sets. Further, the Fed policy changes have not come as a surprise as these signals have been closely followed by the market. One area this could impact, however, could be seen in gold demand by Asian investors so this will continue to be an area to watch.
Stock Market: The benchmark index of the Indonesia Stock Exchange, the Jakarta Composite Index (JCI), has rallied above 5500 earlier in November.
Indonesia Stock Market (JCI):
So far this year, the performance of the index has been great as it has gained roughly 18% and outperformed amongst most of its peers. We will continue watching to see if the latest rate cuts continue these trends.
This column was written by Richard Cox, university teacher in international trade and finance, focusing on lessons in macroeconomics and price behavior in equity markets.