Indonesia Central Bank Holds Rates, Eyes Risks to Growth

Rieka Rahadiana and Neil Chatterjee

Indonesia’s central bank kept its policy rate at a record low of 5.75 percent on Tuesday for a fourth straight month as expected, while flagging external risks to growth in the G20 member because of the euro zone crisis and slowing Asian economies.   

All 15 economists in a Reuters poll had expected Bank Indonesia to keep the rate steady after inflation surprisingly eased last month, with risks tilting towards growth given Europe’s deepening debt troubles. Inflation looks set to stay within BI’s 3.5-5.5 percent target range since sliding global oil prices have reduced the chances of a government hike in retail fuel prices that would have spurred price pressures. 

“The prospects for the global economy are still affected by a worsening and uncertain European crisis, the vulnerable US economy, and economic growth in China and India that is expected to slow,” said Bank Indonesia in a statement that had a more negative tone than in the previous month.

The central bank repeated comments made earlier this year that the risks meant growth in Southeast Asia’s largest economy could fall at the low end of a 6.3 to 6.7 percent GDP forecast for 2012.

Policymakers and investors globally have grown increasingly concerned over fallout from the EU debt crisis, and China surprised markets last week by announcing its first rate cut since the global financial crisis in 2008/09. Worries that the debt crisis will hurt demand for Asian exports have prompted economists to scale back expectations for Indonesian rate rises this year. Most economists see the central bank keeping the policy rate steady for the whole of 2012.

“This position is consistent with BI having ‘taken out insurance’ earlier in the year by a larger than expected magnitude of rate cuts … The current policy stance is consistent with a reasonably robust growth and inflation outlook,” said Aninda Mitra, economist at ANZ in Singapore.    

Inflation easing

Inflation in Indonesia picked up to a seven-month high of 4.5 percent in April from a year earlier but eased slightly in May. Reflecting slowing global demand, April exports fell to create the country’s first trade deficit in nearly three years.

Yet domestic demand remains buoyant, with retail sales up 10.5 percent in April and bank loans growing by nearly 26 percent from a year earlier.

Remarkably, retailers are confident about sales in coming months, reflecting the economy’s resilience to global woes that made the country an emerging market investor favorite in recent years and led rating agencies to lift it to investment grade credit status.

Nervous investors, however, have turned to selling rupiah assets this year, making the currency the worst performer in Asia. The rupiah was little changed after the central bank announcement at 9,440 per dollar, down 0.5 percent on the day and 4 percent this year.

Bank Indonesia will soon start issuing dollar term deposits in an effort to relieve a local scarcity of the US currency which has weighed on the rupiah, and said on Tuesday it will maintain sufficient market liquidity to stabilize the currency.

The central bank has been intervening heavily to limit the rupiah’s fall, pushing down its foreign exchange reserves by about $5 billion in May, but the currency is expected to remain under pressure with investor short positions at their highest since the 2008 financial crisis. 

“Rupiah weakness and managing inflation expectations may limit monetary space for [policy] easing,” said Chua Hak Bin, economist at Bank of America Merrill Lynch in Singapore. “We expect BI to stay on hold for the rest of the year … Stimulus will come from the fiscal side.”

Reuters