Bank Indonesia (BI) delivered a 25bps hike at its April meeting, to stabilise the rupiah and pre-emptively guard against inflationary risks stemming from currency depreciation.
Maybank Research Pte Ltd, in its Indonesia Economics note today (Apr 25), said the rupiah has depreciated 2.3% against the dollar over the past month, as a dial-back in Fed rate cut bets and heightened Middle East tensions sparked a flight to safe havens.
Maybank had assigned 40% probability of a hike today, and 60% probability of a hold. BI’s policy rate has now risen to 6.25%, the highest level since the benchmark rate was introduced in 2016. Overnight deposit facility and lending facility rates were also hiked 25bps to 5.5% and 7% respectively.
BI’s baseline scenario (above 75% probability) is for the US Fed to cut by only 25bps in the fourth quarter, likely in December. The central bank also sees potential risk of no Fed pivot this year, and for the first US rate cut to be pushed back to early 2025. BI’s policy rate differential vis-à-vis US Fed Funds Rate currently stands at 0.9% point.
Even amidst broad-based US dollar gains, BI sees the rupiah remaining stable at 16,200/USD in the second quarter and expects the currency strengthening to 15,800/USD in 4Q. BI will continue utilising all instruments to strengthen rupiah stabilization, including FX intervention, liquidity management, purchase of government bonds in the secondary market if needed, and other necessary steps.
Foreign reserves eased to about USD140.4bn in March (vs. $144bn in Feb), but remain above the USD133bn in Oct 2023, when BI last delivered a rate hike.
BI Confident on Inflation, Positive on Growth
BI continues to be confident that headline inflation (3.05% in Mar) will remain within its 1.5% to 3.5% target range this year. Governor Perry Warjiyo mentioned that volatile food inflation (a key inflation driver at +10.3% in Mar) would ease in line with the crop harvest season and continuous policy coordination between the government and BI to shore up food supply.
BI maintained its GDP growth forecast at 4.7%-5.5% in 2024 (Maybank forecast: 5.1%), and expects GDP growth in the first and second quarter to be higher than 4Q 2023. BI mentioned that growth is being supported by robust household consumption during Ramadan and Eid, while investment has been buoyed by the continuation of National Strategic Projects (PSN) and private property development.
Credit growth accelerated to 12.4% in 1Q 2024 (vs. 11% in Feb), with full-year growth expected at 10%-12%. Macroprudential liquidity incentives (KLM) will be strengthened from 1 June to boost bank liquidity by $6.2bn.
BI’s current account deficit forecast was maintained at 0.1% to 0.9% of GDP in 2024. Maybank expects the first quarter current account deficit to widen when compared to 4Q (-0.4% of GDP), given that the goods trade surplus ($7.3bn) was the lowest since 2Q 2021.
Expect BI to Stand Pat in 2024, Pencil in 75bps of Cuts in 2025
Maybank expects BI to keep the door open for further policy tightening, even though our base case is for the central bank to stand pat going forward. As BI’s primary policy priority remains currency stability, there is a risk that a continued depreciation of USD/IDR at the pace seen in recent weeks may trigger another rate hike.
Asia’s hawks get put on alert after Indonesia’s shock rate hike
Investors are looking for the next policy domino to fall in Asia amid an escalating campaign against a resurgent dollar, after Indonesia used a surprise interest rate hike to defend the rupiah.
The currencies of Japan, South Korea, Thailand, Taiwan, Malaysia, the Philippines and India are all trading within sight of multi-year lows, raising the odds for local authorities to take firmer action to stem the slide. Won and ringgit swaps, for example, are already pricing in a less dovish stance by the two local central banks.
Indonesia’s unexpected monetary tightening this week demonstrates the precarious position of central banks as they grapple with the outlook of higher-for-longer US interest rates. Policymakers across Asia must choose between damping economic growth or protecting exchange rates that are in free-fall.
“The surprise hike by Indonesia’s central bank will certainly let other EM central bankers sit up straight,” Bloomberg quoted Frederic Neumann, chief Asia economist at HSBC Holdings plc saying. “Even as inflation has normalised across much of Asia, the spectre of further dollar strength is keeping central bankers in the region on the defensive.”
While China has been contending with a housing crisis, lacklustre growth and a weak yuan for months, countries like the Philippines also started the year with the prospect of rate cuts. But the picture shifted after sticky US inflation prompted traders to push back bets on the timing of policy easing by the Federal Reserve (Fed).
The prospect of a less dovish Fed means the pick up in US yields relative to Asia may remain high, likely spurring a withdrawal of global funds from the region and driving down local currencies. As such, India is set for its first month of debt outflows in more than a year, while Thailand and Indonesia are also recording net fixed income withdrawals.
Both Japan and Taiwan raised interest rates in March, though their currencies have since declined. The yen weakened beyond 155 per dollar for the first time in more than three decades this week, fuelling risks of intervention by authorities.
The Bank of Thailand said Wednesday that the decision earlier this month to keep rates steady provides policymakers options to deal with unexpected global and domestic challenges.
In the Philippines, authorities risk missing their 2%-4% inflation target for the third straight year in 2024. The country may be forced to delay rate cuts should the peso weaken further, its finance secretary told Bloomberg in an interview last week.
The Reserve Bank of India similarly struck a hawkish tone at its April policy review, with economists pushing back their expectations for rate cuts, given growth rates of above 8%.
Policymakers are already resorting to other methods to stem the exchange-rate slide, from verbal warnings in South Korea to pleas by officials in Malaysia and Indonesia for companies to convert their overseas earnings. India, Indonesia, Thailand and Vietnam have all intervened to defend their currencies.
“Not every central bank will use policy rates to support their currencies,” said Fiona Lim, a senior currency strategist at Malayan Banking Bhd. “It depends on whether the economy is able to withstand higher interest rates. There are other ways to support currencies.”
