Bank Indonesia gets ahead of the curve
Web Posted on : Mon, 04 Jun 2018
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Indonesia’s central bank hiked its policy interest rate by another 25bps to 4.75% on May 30 following quickly on the heels of the previous 25bps hike on May 17 this year. The decision was taken at an interim Board meeting with the next monetary policy meeting scheduled for June 24th. The new Governor of BI noted at the press conference that “BI will continue to calibrate local and domestic market developments to utilise room for further rate hikes in a measured way”.
Bank Indonesia (BI) has been increasingly pro-active to anchor inflation expectations and hiking its policy rate in the face of rising interest rates in the US, and more volatile capital flows to emerging markets (see Emerging Market capital flows prove more volatile in 2018). The latest interim data from the Institute for International Finance (IIF) confirm that emerging markets are continuing to see debt and equity portfolio outflows in recent weeks.
The Federal Reserve is expected by the financial markets to hike its Fed Funds target range by another 25bps on June 14th to 1.75-2.0 percent. This would be the second rate hike this year, with the Fed’s own macroeconomic projections pointing to one more rate hike before the end of the year. At the same time, bond yields in the US have also been rising thus making US fixed income assets more attractive to international investors. By raising it’s own policy rate, Bank Indonesia is able to maintain the interest rate differential in favour of Indonesian assets thus limiting any capital outflows that may emerge as a result of higher US interest rates.
To mitigate the negative impact on growth from higher policy rates, BI has recently given indications that it intends to ease a number of prudential regulations, which could include increasing the loan-to-value ratio, cutting down-payment requirements on new bank lending, and adjusting lower reserve requirement rules. At the same time, the Finance Ministry is pursuing tax holidays to incentivize investment loan demand. These policy moves point to a high degree of policy coordination which, when taken together, should bolster investor confidence that the authorities are aligned on how the policy framework should respond to tighter global financial conditions.
The Rupiah exchange rate has weakened by 3.1% since the start of the year, but the move by Bank Indonesia should reduce the risk of any sudden stop in capital flows and disorderly moves in the exchange rate. At the same time, investor confidence is underpinned by well-anchored inflation expectations.
Market analysts now expect a further rate hike from BI in Q3 of this year, continuing to keep pace with the Federal Reserve. While this increases downside risks to growth, they are likely to be limited by the easing of macro-prudential regulations that will help support credit growth and domestic demand, and investor confidence that the policy framework is responsive in the face of higher global interest rates.