Bank Indonesia Ending the Era of High Interest Rates?

Recently, Bank Indonesia has cut borrowing costs and so far this year the reductions have totaled 1.25 percentage points. This has also impacted currency values, as the US Federal Reserve (Fed) has declined to raise interest rates. Bank Indonesia did cut its seven-day repo rate from 5.25 percent to 5 percent, so it is still clear that the global economy is showing slower momentum. As result of subdued inflation and stability in both the current account deficits and exchange rates, the economy has created policy space for rate cuts from Bank Indonesia.

Chart View: Indonesia Interest Rates

Recently, expectations with respect to Indonesia's GDP growth for the remainder of 2016 were revised down (toward 5.1 percent) as the government decided to cut IDR 137 trillion from its spending programs. The lower RR rate implemented at the September, 2016 policy meeting should be able to offset some of the negative impact of lower public spending, so it is possible that the effects on the Indonesian rupiah will be limited.

Chart View: Indonesia’s Economic Indicators

As the chart above shows, the inflation rate has remained well-controlled and is moving a bit slower given the economic growth constraints we are currently seeing. These indicators are good assessing the level of increased economic competitiveness that is seen throughout Indonesia.

It should be understood that there could be some significant benefits in having the lower interest rate. Lower rates reduce the costs of funding for business and those business are able to get loans more easily because deposits from commercial banks capture lower interest costs. Overall, this will make it easier for Indonesian corporations to enhance profit margins over the next few quarters.

In addition to this, these factors will increase the purchasing power of Indonesian consumers and banks will try to give larger loans for commercial properties and credit for smaller products like smartphones, computers, and home appliances. This will help circulate money in the broader markets.

The expected result is that annualized GDP will be higher and better momentum will be seen in the economy.

For Bank Indonesia, the expectation is that this lower interest rate will lift Indonesia’s credit growth and will establish Southeast Asia's largest economy on a better footing. Rising credit growth as a result of business expansion and higher household consumption should boost economic data overall, and help propel the value of the Rupiah.

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.

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