Bank Indonesia Lowers Key Interest Rate in Surprise Move

Most analysts were surprised to see the central bank lowering its key interest rate; the bank’s first rate cut in three years. As such, Bank Indonesia became the 18th central bank to ease its monetary policy in 2015. In fact, speculation occurred that Bank Indonesia may ease its monetary policy further this year until the moment that the US Federal Reserve decides to raise its key interest rate, a move that is expected to result in severe capital outflows from emerging economies, including Indonesia (particularly as it is plagued by a wide current account deficit which signals that the country is relying on foreign capital inflows), and thus is expected to be anticipated by a higher BI rate.

Indonesia's Benchmark Interest Rate (BI Rate):

Bank Indonesia is confident that inflation is under control. After having accelerated sharply due to a subsidized fuel price hike in November 2014, inflation eased in January 2015 to 6.96 percent year-on-year (y/y) from 8.36 percent (y/y) in the preceding month. The main reason why Indonesian inflation eased markedly at the start of 2015 was because administered fuel prices were lowered in January, a move that was made possible amid the low global oil prices environment. At the year-end inflation is expected to fall within the central bank’s target range of 3-5 percent (y/y).

 
Inflation in Indonesia:

Month	Monthly Growth           2013	Monthly Growth           2014	Monthly Growth           2015
January	1.03%	1.07%	-0.24%
February	0.75%	0.26%
March	0.63%	0.08%
April	-0.10%	-0.02%
May	-0.03%	0.16%
June	1.03%	0.43%
July	3.29%	0.93%
August	1.12%	0.47%
September	-0.35%	0.27%
October	0.09%	0.47%
November	0.12%	1.50%
December	0.55%	2.46%
Total	8.38%	8.36%	-0.24%

^{Source: Statistics Indonesia (BPS)}

Inflation of Indonesia 2008-2014:

	2008	2009	2010	2011	2012	2013	2014
Inflation (annual percent change)	9.8	4.8	5.1	5.4	4.3	8.4	8.4

^{Sources: World Bank}

Meanwhile, the country’s current account deficit - although improving - can still be labelled unsustainable. The current account deficit (which is the broadest measure of trade in goods and services) was USD $6.2 billion, equivalent to 2.81 percent of gross domestic product (GDP), in the fourth quarter of 2014 (improving from a revised 2.99 percent of GDP in the preceding quarter). Regarding full-year 2014, the current account deficit was USD $26.2 billion, or 2.95 percent of GDP, from a (revised) deficit of USD $29.1 billion (3.18 percent of GDP) in 2013. Generally a current account deficit exceeding three percent of GDP is labelled unsustainable. Although Indonesia’s deficit managed to fall just below the three percent of GDP mark, it is important for the country to foster this improving trend in order to safeguard the country’s financial fundamentals and restore investors’ confidence in Southeast Asia’s largest economy. This is particularly important ahead of a looming US interest rate hike later this year which is likely to trigger capital outflows; the better the country’s financial fundamentals, the less capital outflows it will see. However, given the sluggish global economy, Indonesia will face difficulty to spur export growth. Yesterday, Statistics Indonesia (BPS) released the country’s latest trade data. In January 2015, Indonesian exports fell 8.09 percent (y/y) to USD $13.30 billion. Indonesia, an important (raw) commodities exporter, is plagued by weak global demand, thus triggering low commodity prices.

A lower key interest rate should translate into credit growth (boosting private investment) and thus support economic growth. It is time for the Indonesian economy to finally rebound after having been experiencing slowing growth since 2011. Last year, GDP growth was recorded at 5.02 percent (y/y), the slowest growth pace in five years. The administration led by President Joko Widodo stated repeatedly that investment growth should become the main engine of the Indonesian economy in 2015. Apart from private investment, enhanced public investment (made possible by reforming the government’s fuel subsidy policy) in infrastructure should have a multiplier effect. Moreover, household consumption (also an important pillar of support for economic growth in Indonesia) should also rebound as consumers’ purchasing power improves in a lower interest rate environment. However, it should also be noted that both investment (whether in infrastructure or not) and enhanced domestic demand amid improving purchasing power will most likely boost the country's imports thus putting pressure on the current account balance as well as on the rupiah exchange rate.

Regarding the global economy, Bank Indonesia said that although the US is projected to grow higher than initially expected, sluggish economic growth in Japan and China as well as the Eurozone will curb global economic growth. The European Central Bank’s decision to launch its own quantitative easing program - in an effort to combat deflation in the Eurozone - is expected to cause foreign portfolio capital to Indonesia (so-called ‘hot money’).

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