Bank Indonesia holds rates as focus shifts to QE expansion

Indonesia’s central bank left its key interest rate unchanged to shore up support for the sagging currency, saying quantitative easing could be more effective right now than rate cuts in reviving Southeast Asia’s largest economy.
After 100 basis points of easing so far this year, Bank Indonesia kept the seven-day reverse repurchase rate at 4% Wednesday, as expected by 20 of 25 economists in a Bloomberg survey. The other five predicted a 25 basis-point cut.
“While there is space for rate cuts, we believe that BI’s intensifying QE programme calls for a more cautious pace of conventional easing,” HSBC Holdings Plc economist Joseph Incalcaterra wrote in a research note. “We believe the central bank will look to deliver one last opportunistic rate cut in the fourth quarter.”
Bank Indonesia is trying to balance the need for more stimulus with risks that the currency may weaken further if it continues lowering rates.
The pandemic pushed Southeast Asia’s largest economy to its first contraction in more than 20 years in the second quarter, while the rupiah is down more than 6% against the dollar since the start of the year, making it the worst performer in Asia.
The currency maintained gains of as much as 0.5% against the dollar after the rate decision, snapping eight days of losses.
The yield on benchmark 10-year government bonds extended its decline to 3 basis points at 6.717%, its lowest level since March 5. The nation’s benchmark stock index closed 0.4% lower, its first decline in seven sessions.
Bank Indonesia will “continue strengthening the synergy in monetary expansion with accelerated government fiscal stimulus to support the national economic recovery,” Governor Perry Warjiyo said at a briefing in Jakarta, where he repeatedly emphasised the need for close coordination with the government.
“Bank Indonesia shifted its emphasis to quantitative tools, leaving interest rates unchanged on Wednesday in support of the rupiah and external stability. This was a prudent pause, in our view, coming in the wake of Friday’s announcement that the central bank’s burden-sharing arrangement with the government will extend to next year’s budget as well. Even so, we think domestic demand in 2H will remain weak enough to justify another 25 bps of easing before year-end”, says Tamara Mast Henderson, Asean economist.
There’s still pressure to cut rates after the government last week revised down its forecast for this year’s gross domestic product growth to a range of -1.1% to 0.2%. At the same time, inflation remains below the lower end of the central bank’s target band and the current-account deficit is improving as the trade surplus widens, helping to relieve pressure on the exchange rate.
“There is still room for rate cuts as growth risks mount,” said Enrico Tanuwidjaja, a Jakarta-based economist at PT Bank UOB Indonesia, who also expects a 25 basis-point cut in the fourth quarter.
Aside from cutting rates, the central bank has been expanding its toolkit this year to support the economy. It has reduced the reserve ratio requirement for banks to boost lending and increased its purchases of government bonds to stabilise markets and finance fiscal stimulus.
Warjiyo said this year’s burden-sharing agreement on deficit financing will be a one-off, but said the central bank will remain a standby buyer of government bonds in the primary market next year.
Other points from his briefing:
Bank Indonesia will continue strengthening monetary expansion to boost the economy, and will help finance the 2020 budget deficit.
The bank maintained its 2%-4% inflation forecast for the year.
This year’s current-account deficit will likely be less than 1.5% of GDP.
The bank will continue intervening to defend the rupiah, which has scope to rise. The bank tweaked some macro-prudential settings, for example lowering down-payment requirements on auto loans, to boost consumption.
“We sense that monetary policy makers are comfortable with the fact that the latest leading indicators are showing signs of recovery, although still below pre-pandemic levels,” said Wisnu Wardana, an economist at Bank Danamon Indonesia in Jakarta. “We think unlocking the shift in consumer behaviour, not just on what but how or when they spend, would be key to constructing effective policy measures.”