BI's Prudent Interest Rate Policy Amid Pressure

Penulis: Martha Ruth Thertina

21/9/2018, 19.29 WIB

Amid pressure on the rupiah and domestic economy, Bank Indonesia is expected to raise its benchmark interest rate following a possible increase in the US rate.

Bunga bank
Denphumi Jaisue |

Central banks of developing economies are preparing to face further increases in the US central bank interest rate, the Fed Fund Rate. In its board of governors meeting next week, Bank Indonesia (BI) is expected to once again raise its seven-day reverse repo rate to reduce the outflow of foreign funds and maintain the rupiah exchange rate. A number of economic risks also pose a challenge to BI policy.

On 25-26 September, the US central bank The Federal Reserve (The Fed) will hold a meeting in Washington, DC to determine its monetary policy. Expectations of Fed officials remain the same, wanting two more increases this year – most likely in September and December.

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A number of countries are monitoring the decision, and have made anticipatory steps, with Turkey’s central bank has recently raising its interest rate.

BI is waiting for the results of the Fed meeting next week before determining its interest rate policy. Since May it has raised its seven-day reverse repo rate four times at a total of 1.25 percent. This was intended to dampen the pressure of foreign fund outflows from the financial market and the weakening of the rupiah exchange rate, which were mainly triggered by US monetary and fiscal policies.

However, after an aggressive increase a few months ago, BI seems confident with the benchmark interest rate maintained at 5.5 percent since August. It was different in May, when BI held an additional meeting ahead of the Fed Fund Rate announcement to make the benchmark interest rate more attractive in attracting foreign funds and strengthen the rupiah.

However, economists in a Bloomberg survey say BI has a big chance to raise the benchmark interest rate again in its meeting next week. The increase is estimated at 25 basis points, although some project it at 50 basis points.

Bank Central Asia (BCA) Chief Economist David Sumual predicts the benchmark interest rate will rise 50-100 basis points for the rest of the year and at least 75 basis points next year, reaching above 7 percent next year.

External pressure is not the only reason. A deficit in the trade of goods and services and the current account is making the foreign exchange (forex) supply limited so as to further weaken the rupiah. As a consequence, the increase in the benchmark interest rate in line with the increase in the Fed Fund Rate is important. “At least, the increase is the same [with the increase in the Fed] or greater,” David told D-Inside.

Research Director at the Centre of Reform on Economics (Core) Indonesia Pieter Abdullah Redjalam has the same view: an increase in the BI benchmark interest rate equivalent to the Fed. It will be different if there are fundamental improvements, such as the current account balance.

In August, the goods trade balance recorded a deficit of US$ 1.02 billion, and the total deficit this year is US$ 4.09 billion. The current account is also in deficit and the estimated value could reach US$ 25 billion by the end of this year.

There is also a view that BI does not have to be aggressive in raising the benchmark interest rate as historically it policy only dampens the weakening of the rupiah in the short term, even though the high interest rate will cause a slowdown in economic growth. Another risk is the reduced attractiveness of investment in the stock market because corporation profit potential is shrinking.

BI Deputy Governor Dody Budi Waluyo said BI’s monetary policy is still the same: ahead of the curve. So, it will be anticipatory to face monetary policy in developed countries, including the US.

However, BI also considers other factors before making decision for the interest rate, such as the trade balance and economic growth that is at risk of slowing down in the second half.

A D-Inside source in a financial company said BI Governor Perry Warjiyo also considers the economic growth factor in determining the direction of his monetary policy. “This is different from the previous BI Governor Agus Martowardojo, who was more focused on monetary matters,” the source said.

The government expects this year’s economic growth to be around 5.2 percent, and an optimistic target at 5.3 percent next year, even though Finance Minister Sri Mulyani Indrawati said there is a risk of the target falling to 5.15 percent.

Financial Market Conditions

Market participants began taking positions ahead of the Fed Fund Rate announcement this September. Yields on 10-year US Treasury Notes have soared from the end of August to re-breach 3 percent since last Friday (14/9).

The US dollar index (DXY) fluctuated sharply with a downward trend even though the index level was still quite high at 93.

Domestically, the Jakarta Composite Index (CSPI) also fluctuated. Foreign investors recorded a net buy of Rp 157.98 billion in the past week. But in the past month there was a net sell of Rp 2.13 trillion and a total of Rp 53.48 trillion this year.

The yield on the 10-year government bonds (SUN) was 8.26 percent, down from 8.58 percent at the beginning of September. Referring to Ministry of Finance data, sell-offs by foreign investors will occur frequently in the SUN market.

In early September, foreign SUN ownership was Rp 853.77 trillion. On Wednesday (19/9), it fell by Rp 16.61 trillion to Rp 837.16 trillion. Compared to its highest position so far this year of Rp 880.2 trillion at the end of January, foreign ownership has fallen by Rp 43.04 trillion.

As a result, the rupiah exchange rate weakened sharply against the US dollar. In spot-market trading the rupiah breached Rp 14,938 per US dollar at the beginning of September, before stabilizing at 14,800.

On Thursday (20/9), the rupiah exchange rate closed at 14,849, weakening 1.79 percent from the previous month and 9.55 percent when compared to the end of last year.