Indonesia Takes Taper Talk in Stride, Holds Rates at Record Low

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Bank Indonesia left its policy rate unchanged at a record low on Thursday, maintaining its support for a pandemic-hit economy and declaring that it is ready to weather any volatility from the Fed’s more restrictive message overnight.

The Indonesian central bank left the seven-day reverse repurchase rate at 3.5%, as expected by all 30 economists interviewed by Bloomberg. It’s the fourth straight month that interest rates have stayed at their record lows, and Bank Indonesia previously signaled that it could stay at those levels for the remainder of the year.

“The decision is in line with our low inflation forecast and has maintained the stability of the rupiah and efforts to strengthen the national economic recovery,” Governor Perry Warjiyo told reporters in Jakarta. The central bank will be accommodating in its policies to stimulate corporate lending, which will help the economy recover, Warjiyo said.

The move should help policymakers protect the rupiah from another round of taper talks after the Fed accelerated its expected pace of monetary tightening on Wednesday. The rupiah, which has fallen 2.1% against the dollar this year, is one of the currencies that is prone to volatility as foreign investors shift their portfolios away from emerging markets.

The rupiah fell as much as 0.9% on Thursday, the biggest drop since February 26, although most of the drop following the Fed decision came ahead of the Bank Indonesia meeting. The country’s benchmark stock index lost 0.2%, while benchmark 10-year government bond yields rose 8 basis points to 6.5%, their highest level since May 20.

“Bank Indonesia’s decision to leave its key rate unchanged at 3.5% would not be surprising on normal days, but it is particularly to be expected that it will come overnight right after the Fed’s radical tilt,” Wellian Wiranto said. Economist at Oversea-Chinese Banking Corp. in Singapore. “While there is a risk that BI will have to respond to a new domestic economic downturn due to the virus resurgence, its ability to further cut interest rates has been severely constrained by global developments overnight. We therefore now expect a very low probability of an interest rate cut this year. “

Remain accommodating

While some of its peers have begun to point out political change, Bank Indonesia has pledged to keep politics accommodative for as long as possible to support a weak economy struggling to get Covid-19 under control. Even after hitting a five-month high of 1.68% in May, inflation remains well below the central bank’s target of 2% to 4%.

What Bloomberg Economics Says …

“The balance between currency stability and Bank Indonesia’s growth support considerations could become more difficult in the second half of the year – a time when the US recovery is likely to gain momentum while Indonesia’s recovery hopes are pushed further into 2022. We continue to expect the central bank to cut rates. “Unchanged for the remainder of this year and much of 2022.”

– Tamara Mast Henderson, Asean economist

Varyyo said global financial volatility should ease as the Fed’s policy outlook clears. Bank Indonesia doesn’t expect the Fed to begin curbing its asset purchases until the first quarter of next year, Warjiyo said.

“We have seen global spillover episodes from time to time,” Warjiyo said, referring to the “taper tantrum” in 2013 – when the Fed began unwinding its bond purchases from the financial crisis era – and massive outflows at the height of the die Pandemic last year. “Of course we will continue to be vigilant and ensure the stability of exchange rates and financial markets,” he said.

A new wave of coronavirus infections threatens to derail the economy, which until recently showed signs of a turnaround. Indonesia added more than 55,000 new cases in the week ending June 13, the biggest increase since February after gatherings on the Eid al-Fitr holiday and more communicable strains made the spread of the virus worse. The government has tightened movement restrictions and extended vaccine rollout to all adults to stem the surge, which is expected to continue through July.

Recovery sign

Prior to the surge in Covid, Indonesia’s mobility and retail sales drove consumption, which accounts for more than half of its gross domestic product. Exports and imports also skyrocketed in May, accompanied by record levels of factory activity. Indonesia aims to come out of its recession this quarter and post growth of 4.5% -5.3% for the full year.

“The main reason we don’t expect any further rate cuts is the uncertain outlook for the currency,” wrote Gareth Leather, Senior Asia Economist at Capital Economics, after the decision. “We believe the rupiah is likely to decline further as fears of higher inflation in the US drive bond yields and the dollar higher. A high level of foreign currency debt makes Indonesia susceptible to strong currency collapses. “

Further points from the briefing:

Varyyo expects Indonesia’s recovery to continue in the second quarter and reiterates full-year outlook for GDP growth of 4.1% to 5.1%. The bank maintained its inflation outlook of 2-4% for the year and theirs Current account forecast at 1-2% of GDP deficit Bank lending declined 1.28% in May, the eighth consecutive month of declines, but credit demand is improving as business activity picks up

(Updates the market levels in the fifth paragraph, adds the comment from Bloomberg Economics in the text box.)

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