Indonesia: Bank Indonesia cuts rates amid downward inflationary pressures, supports government's growth agenda
February 17, 2015
At its 17 February monetary policy meeting, the Central Bank decided to cut the BI policy rate from 7.75% to 7.50%. The move, which came as a surprise to the market, reverses the cautionary 25 basis point hike that was made last November to curb inflationary pressures after the government increased the price of subsidized fuels by more than 30%. Global oil prices are currently down around 50% compared to last summer, which is offsetting the impact of the subsidy cut and pushing inflation downwards. These new inflationary dynamics, and the government’s objective of stoking economic growth, prompted the Bank to cut the policy rate. The Bank also cut the deposit facility rate from 5.75% to 5.50%, while the lending facility rate was left unchanged at 8.00%.
Bank Indonesia acknowledged that annual economic growth slowed in 2014 to 5.0%. However, the Bank emphasized that the economy picked up slightly in Q4 compared to the previous period and interpreted this result as a sign that the contractionary phase observed in recent years has come to an end. The Bank explained that modest gains in Q4 were driven by construction investment and government consumption. Meanwhile, the external sector continued to suffer amid weaker demand from emerging economies and falling commodity prices. Growth is expected to accelerate this year on the back of government infrastructure projects and further structural reforms.
The Bank explained that consumer prices dropped 0.24% over the previous month in January and that core inflation remains under control. Annual inflation receded from 8.4% in December to 7.0% in January. The Bank expects that the low international price for oil will help bring inflation back within the target corridor of 4.0±1.0% in 2015.
Regarding the external sector, the Bank emphasized that the balance of payments improved in the final quarter of 2014, primarily due to a smaller current account deficit. A growing non-oil and gas surplus, coupled with a decreasing oil and gas deficit, are helping reduce the current account deficit. The capital account recorded a large surplus at the close of last year due to positive growth in foreign direct investment, driven by increased perceptions about the domestic economic outlook.
In terms of currency developments, the rupiah continued to depreciate against the U.S. dollar in January. Solid economic growth in the U.S. and the ECB’s announcement that it would loosen its monetary policy have driven the dollar to appreciate further. However, the Bank considers that a weaker rupiah will benefit the current account deficit through lower imports of consumer goods and greater export competitiveness.
Author: Carl Kelly, Economist