Indonesia's key interest rate

[00:00:00]Welcome back. In your business tonight, Indonesia's Central Bank unexpectedly kept its key rate steady at 5.75% bringing an end to a run of three successive rate hikes, including a surprise off-cycle increase in early June.

[00:00:17]Bank Indonesia has raised rates by a full percentage point this year as part of efforts to support the rupiah, which is weighed down by surging oil prices and investor concerns over the country's fiscal health.

[00:00:31]This time, however, the bank says it will use other incentives to attract foreign capital to stabilize the rupiah, which are less inflationary.

[00:00:40]And a check on how Indonesian markets performed today, the Jakarta Composite down 0.9% and the rupiah gaining marginally against the dollar.

[00:00:52]And for more insight, we're joined by Radhika Rao, who is a senior economist and executive director at DBS Bank.

[00:00:58]Radhika, welcome to the show. Now, markets were expecting another rate hike. So, what changed Bank Indonesia's calculus here?

[00:01:09]>> Hey, so the Bank Indonesia has actually raised rates by just mentioned about 100 basis point between May and June. And I think we need to remember the backdrop against which they did that, which was when the currency was under a way one-sided pressure. Dollar rupiah was breaking through psychologically key barriers, going to a record low and we've seen it gone it will go past 18,000. And at the same time, there were other things that were also going against the currency. I mean, the fiscal concerns, some institutional decision making, you know, rate rating index provider equity index provider also on holding on and review. So, quite a lot of negatives I would think which was adding to the depreciation pressures.

[00:01:52]And against that, certainly the uh, central bank hiked rates. And in fact, one one was an interbank move, another one was a bigger than expected rate hike.

[00:02:03]Uh, now fast forward to now, I think geopolitical tensions have come back, but what you've also seen is the currency is much more is much more well-behaved, I would say, because in the interim you've actually seen foreign inflows come back, and you've also seen some of the fiscal concerns that were a worry earlier also being addressed by the government.

[00:02:22]So, I think against this backdrop the central bank perhaps felt that, you know, they could preserve ammunition for the time being, use it later in the year if say, you know, this war escalates further, oil prices really shoot up beyond $100, and at the same time what other external forces do. I think they want to keep some powder dry, and I think that's why they, you know, prefer to pause, and they'll just take account of what have been what has been developing until in the past month.

[00:02:52]>> Right. Now, speaking of which, instead of raising rates, the central bank is betting on new incentives to attract foreign capital. Is that enough you think to support the rupiah, or is it simply just buying time at this point?

[00:03:07]>> Yeah, we've seen regional central banks actually do that of late, where, you know, initial they tried to use a mix of rate and non-rate policy measures.

[00:03:17]You know, typically if the currency is the problem, they try to put in some non-rate measures by way of making it easier on the investors by taking off away the currency risk.

[00:03:28]So, in that from that perspective, Indonesia is not alone, it is in good company in terms of what the regional central banks have also done. I think this move was already set into motion a few weeks back when BI had actually, you know, taken about 10% discount on the hedging cost. And this time they have taken it up a bit more. Apart from that, they're also trying to solve a few more issues.

[00:03:51]They've given so you know there's an instrument called DNDF they're giving some support in that for certain other currencies. They are also making sure that there's a bit of a liquidity asymmetry in the banking system. Some have some banks have more, some less. So they're trying to address that as well. So suddenly putting in these measures in place to stabilize the currency, backstop the currency, improve sentiments while at the same time like I mentioned earlier not you know too proactively hike rates altogether.

[00:04:24]For our own view actually we had only one more rate hike which was in the baseline. I'm just kind of maintained that and I think I'm still keeping that because [snorts] that's going to be really subject to what happens globally.

[00:04:35]I think from a domestic point of view certainly whatever was a worry in the first half is being addressed in the second half the year.

[00:04:43]>> Yeah and speaking of what happens globally then the rupiah is still trading near 18,000 to the US dollar.

[00:04:49]How much of that pressure comes from global risks like the Middle East conflict and also the US interest rates and how much of it reflects concerns about Indonesia's own economy?

[00:05:02]>> And that's an interesting question because you know before the Middle East escalation actually rupiah was already on a depreciating path right? So if you talk about January, February or late last year the currency had already begun to lose ground. So the Middle East crisis in some way only aggravated the problem.

[00:05:20]>> [snorts] >> Right now we are at a place where there were nagging worries on say for example ratings outlook you know what the equity index provider is going to say how the geopolitics are going to shape, what's going to happen to the US Fed. So a lot of questions which have remained unanswered but at least on the domestic side I think the authorities have already taken cognizant of the fact that there are some issues that were you know had to be resolved. Of particular interest what what has happened to the fiscal outlook of the economy and I think there you have really seen the government adopt a middle path which is that they don't want to increase fuel prices which basically means that they're going to maintain petroleum subsidies. If you're going to maintain petroleum subsidies, you need to make space elsewhere in the budget in the spending you know scale and what they have done is they have cut the flagship program flagship welfare program. They've cut the allocation by almost a third. There are indications they could it could be trimmed even more. So that you kind of gives you again the fiscal space, takes away that worry that you know, 3% of GDP which is their threshold for deficit could be busted. So from I hence I would say at this point externals are still not that great but at least domestically some of the problem worries or the some of the concerns have been I wouldn't say completely met but have been addressed for the time being. And one more point here was the rating outlook and the overhang because of that. We've had S&P in fact come out and affirm the country's ratings as well as outlook. Again that was another tailwind for the currency and sentiments in general. So yes to answer your question, I think it's a mix of domestic and external. External still you know, not far from resolved but domestically at least the pain points that were there earlier have eased off compared to say at least a couple of months back. Mm. Radhika, thank you so much for your analysis.

[00:07:18]That was Radhika Rao who is a senior economist and executive director at DBS Bank.