Indonesia: Bank Indonesia unexpectedly loosens monetary policy
August 22, 2017
At its 21 and 22 August monetary policy meeting, Bank Indonesia surprised market analysts by deciding to cut the BI seven-day Reverse Repo rate from 4.75% to 4.50%. The decision notably contrasted expectations of zero change to the policy stance and was the Bank’s first cut this year. Accordingly, the Bank also reduced the lending facility rate from 5.50% to 5.25% and the deposit facility rate from 4.00% to 3.75%.
Behind the Bank’s unexpected cut is subdued inflation and an improved global backdrop. Inflation has hovered around the mid-point of the Central Bank’s 4.0% plus or minus 1.0 percentage point target this year thanks to low inflationary pressure from administered prices, and the Bank introduced a lower target of 3.5% plus or minus 1.0 percentage point for 2018. However, despite controlled price pressures the majority of analysts were expecting no change in monetary policy primarily because of rising interest rates in the U.S. Diverging monetary policy cycles could spark capital outflows from Indonesia, threatening asset stability. In its accompanying statement, however, Bank Indonesia emphasized that external risks have decreased. This is chiefly due to shifting expectations that Federal Reserve hikes will be smaller and later than previously thought.
On top of inflation and U.S. monetary policy, the monetary policy easing was also driven by the need to boost lackluster economic activity. Recently-released GDP data revealed that growth stalled at Q1’s 5.0% in Q2, making it difficult for the economy to reach the upper end of the Central Bank’s 5.0%–5.4% growth forecast for this year. The cut should help support credit growth, which has been weak this year, and the Bank downgraded its projection from a 10%–12% increase in credit to 8%–10% for 2017. The Bank left its GDP forecast unchanged, stating that it expected growth to improve in the coming quarters due to rising investment and consumption, caused in part by looser monetary policy.
Looking forward, the Bank struck a neutral tone and gave few hints as to whether another cut is in the cards. The Bank stated it will continue to keep inflation under control and stimulate growth using a mix of policy tools. Overall, FocusEconomics analysts are divided on the outlook for the policy rate. Euben Paracuelles and Lavanya Venkateswaran, analysts at Nomura, explain their outlook, commenting:
“We believe more policy rate cuts in the near term are unlikely because of our US team’s view that the Fed’s balance sheet roll-off is likely to be announced next month followed by another Fed rate hike in December, as well as prospects for ECB tapering. As such, BI’s next move may be more likely on macroprudential easing, which we have been arguing is an appropriate and targeted policy response to its growth concerns, which mainly emanate from its assessment of sluggish private consumption.”
Our analysts are reexamining their forecasts, and an updated projection for the BI seven-day Reverse Repo rate will be released on 19 September.