April 25, 2024
JAKARTA – Bank Indonesia (BI) has raised its key interest rates in what it calls a “preemptive measure” in light of global risks caused by the uncertain outlook for monetary policy in the United States and geopolitical tension in the Middle East.
The central bank lifted the benchmark BI Rate by 25 basis points (bps) to 6.25 percent. It also raised the rates for its deposit facility and its lending facility by the same amount to 5.50 percent and 7 percent, respectively.
Following BI’s monthly policy meeting, BI Governor Perry Warjiyo explained on Wednesday that the monetary policy authority had considered several scenarios with regard to the US Federal Reserve’s key interest rate, the federal funds rate (FFR), and global conflicts.
He said the scenarios “measure the risks and the probability” of them happening and that BI had assessed how they would affect Indonesia’s macroeconomic situation.
The most likely scenario, termed the “baseline” scenario, is seen to have a 75 percent chance of occurring, while a so-called “potential risk” scenario is deemed less likely and a “tail risk” scenario is seen as the least likely.
The baseline scenario assumes a 25-bps reduction in the FFR to take place in the fourth quarter of this year, probably in December, but under the potential risk scenario, the Fed would only cut its key rate in the first half of next year, albeit by 50 bps. The unlikely tail risk scenario assumes a mere 25 bps cut throughout the entirety of 2025.
After assessing recent macroeconomic data on inflation, job growth and retail spending, all of which veered from expectations, the Fed signaled that its restrictive monetary policy needed to be maintained longer, which analysts took to mean a cut in the FFR rate was not expected before September, if at all this year.
Dashed hopes for a sooner cut prompted investors to hold onto or buy more US dollar assets, pushing up the dollar index that measures the greenback versus six other currencies. The greenback’s appreciation also reflected in its value vis-à-vis Indonesia’s currency.
On the Middle East conflict, Perry said the baseline scenario was “limited retaliation” and therefore a limited increase in oil prices. The potential risk scenario was “a moderate escalation”, while the tail risk was “expansive” escalation.
During times of conflict, investors tend to reallocate funds to so-called safe-haven assets, which are currently taken to include the US dollar and gold. More funds running into the dollar translates into money flowing out of emerging markets, such as Indonesia, weighing on those countries’ currencies, such as the rupiah.
The rupiah has been on a declining trend against the greenback for most of the past year and recently dropped below the psychological threshold of Rp 16,000 per dollar, where it has remained since April 11.
Analysts attribute the latest drop to the Fed’s more hawkish stance, as well as to the recent attacks between Iran and Israel.
The rupiah touched a multiyear low of Rp 16,265 per dollar on Friday, and analysts said it could breach its all-time low of Rp 16,950 per dollar.
However, those assessments were made before Wednesday’s BI Rate hike.
This “preemptive measure” of raising the rate to 6.25 percent was taken to anticipate the potential risk scenario so that the central bank could “go back to the baseline scenario”, said the governor.
Perry added that BI expected the new policy rate to bring the rupiah’s dollar exchange rate to an average of Rp 16,200 in the second quarter of this year, Rp 16,000 in the third quarter and Rp 15,800 in the final three months of 2024.
BCA chief economist David Sumual told The Jakarta Post on Wednesday that the hike “was to be expected” and was “the right step to take”, given that BI’s action of exerting its dollar reserves had not helped much in slowing down the rupiah’s depreciation.
He went on to say that the hike would not hamper the country’s GDP growth because BI had simultaneously rolled out liquidity incentives that could stimulate economic activity in certain sectors, effectively making the two policies “a throttle and a brake”.
Indonesian Employers Association (Apindo) chairwoman Shinta Kamdani said in a press statement published on Wednesday that businesses “understand and respect” BI’s rate hike decision irrespective of how “unideal it is for businesses” given that it would increase funding costs and discourage expansion.
“We hope that, after this increase of interest rates, the rupiah exchange rate will become stable or strengthen in the short term,” said Shinta. Rate hikes should be thought of as the “last resort instrument” that should not be used too frequently, because Indonesia’s real lending rates were “uncompetitive against peer countries in the region”.
Private lender Bank Permata chief economist Josua Pardede wrote in a comment published on Wednesday that underlying external conditions had pushed BI to “take anticipatory measures beyond just intervening in the foreign exchange market”.