Bank Indonesia Expected to Raise Benchmark Interest Rate in May 2018
There is a big possibility that the central bank of Indonesia (Bank Indonesia) will raise its benchmark interest rate (the 7-day Reverse Repo Rate) at the monthly policy meeting in May (scheduled for 16-17 May 2018). Bank Indonesia Governor Agus Martowardojo confirmed that Bank Indonesia is currently preparing "strict and consistent monetary policy measures, including the adjustment of the benchmark rate, as the central bank gives priority to market confidence and macroeconomic stability".
The two key tasks of Bank Indonesia are safeguarding rupiah stability and low (and stable) inflation. While inflation is still rather low (for Indonesian standards) at 3.41 percent year-on-year (y/y), comfortably within the central bank's target range of 2.4 - 4.5 percent (y/y), there is concern about rising inflationary pressures in Southeast Asia's largest economy stemming from the strengthening international crude oil prices as well as imported inflation due to the weaker rupiah.
But more importantly, the Indonesian rupiah has been under heavy pressures in recent weeks amid broad-based US dollar strength. These pressures stem from looming further monetary tightening in the USA, rising 10-year US treasury yields, concerns about a global trade war, rising crude oil prices, as well as high local US dollar demand in Indonesia's April-May dividend payout season.
The rupiah has passed beyond the psychological IDR 14,000 per US dollar level which then caused a high degree of concern among Indonesians, many of whom still have vivid memories of the Asian Financial Crisis in the late 1990s; a crisis that started with a drastically weakening rupiah. Despite having changed to a floating exchange rate regime and having a much stronger financial system (where Bank Indonesia can now actually monitor the flow of money within the system) than in the 1990s, the rupiah passing beyond IDR 14,000 per US dollar is still a sensitive matter for Indonesians as well as source of criticism for the government.
In recent weeks Bank Indonesia has been intervening in markets by selling foreign exchange (hence the nation's foreign exchange reserves tumbled around USD $6 billion over the past two months) and by buying bonds. However, pressures continue and therefore Bank Indonesia's efforts only resulted in the guided depreciation of the currency (which is in line with the rupiah's fundamentals and therefore considered a good approach). However, to improve confidence in the rupiah and make Indonesian assets more attractive investment options for investors, an interest rate hike would be a much stronger approach.
There are still some days to go before Bank Indonesia meets to discuss its monetary policy approach at the May meeting next week. It is therefore important to see how markets react to the latest US inflation data. Slower growth in US core prices could mean that markets expect the Fed to be less inclined to accelerate interest rate hikes. This would mean that the Fed will only raise its benchmark rate by a total of three times in 2018, not four times (thus would reduce some of the heavy pressures on emerging market assets). Still, most analysts remain convinced that the Fed will raise its benchmark at the June policy meeting.
For now, we expect Bank Indonesia to raise its 7-day Reverse Repo Rate by 25 basis points to 4.50 percent at the May 2018 policy meeting.
Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 0.18 percent to IDR 14,048 per US dollar on Friday (11/05).
Indonesian Rupiah versus US Dollar (JISDOR):
| Source: Bank Indonesia