After a two-day board of governors meeting culminating on the 23rd October 2018, Bank Indonesia announced that Indonesia’s benchmark interest rate would remain unchanged at 5.75%, however, it remains to be seen for how long. The announcement to hold the BI rate in October comes after a flurry of five rate hikes over the course of May to September 2018, amounting to a cumulative 150 bps rise. The latest increase of 25 bps at the end of September 2018 also saw an increase to the deposit facility and lending facility rates which were raised by 25 bps to 5% and 6.5% respectively. These measures have been part of a concerted effort to defend the flailing rupiah that has undergone a steep devaluation with its exchange rate at a 20 year low against the US dollar.

Rupiah Under Pressure

Increased external pressures such as President Trump’s protectionist trade tariffs and ongoing tensions with China, coupled with internal pressures to lower the country’s current account deficit have dragged the rupiah exchange rate down to levels not seen since the Asian financial crisis. As Bank Indonesia seeks to stem capital outflows because of a strengthening US dollar and looming Fed rate hikes, the question remains as to what further measures they have at their disposal and their effectiveness as presidential elections loom (See Indonesia's Upcoming 2019 Presidential Elections: What it Means for Investors).

The central bank has already used billions of dollars from its reserves to try to stem the currency rout and increased the frequency of foreign-exchange swap auctions since July 2018 to boost liquidity in Indonesia’s banking system. Bank Indonesia has also introduced measures to lower the hedging cost with the volume of rupiah injected into the market surging almost thirteen-fold in one month. Furthermore, Bank Indonesia has implemented overnight index swaps and interest-rate swaps to provide further hedging tools for investors, exporters and banks in addition to offering a one-month tenor foreign-exchange swap hedging facility.

Sluggish export growth and weak commodity prices coupled with increased imports have also inflamed the growing current account deficit (See Indonesia's 2019 Economic Outlook: Challenging Times amid Political Turbulence). Indonesia’s CAD widened to 3% of GDP in Q2-2018 from the same quarter last year and following the most recent Bank Indonesia governors’ meeting; it appears that it may have widened further in Q3-2018. Bank Indonesia is aiming to keep the CAD at 2.5% of GDP throughout 2019 by taking measures to curb the country’s reliance on imports. In September, the Ministry of Finance announced a list of 900 luxury and basic goods that will become subject to import restrictions after a 50% jump in consumer prices being recorded over the previous two months. These measures are likely to have a negative impact on consumer and household spending and further weaken Indonesia’s economic performance in Q4-2018.

What to Expect

By holding firm in October, Bank Indonesia has chosen to send out a message of confidence to global financial markets following a small trade surplus reported in September. Yet it has also missed out on the opportunity to get ahead in continuing to enhance the attractiveness of the rupiah versus its regional counterparts given that it has been the second worse performing currency in the region.

Looking to the future, the US Federal Reserve is widely anticipated to announce a rate increase in December 2018, prior to this it is likely that Bank Indonesia will move ahead at its November meeting with a rate rise of at least 25 bps to anticipate and fend off further capital outflows, however, this may not be enough to keep investors at bay (See Indonesia’s Fragility & The Fed).

With presidential elections looming in April 2019, Bank Indonesia is under pressure to bring about stability to the country’s key economic indicators so as to bolster the economy. The devaluation of the rupiah and the inevitable rise in costs for doing business and importing goods will therefore likely play a key role throughout the election campaign as the incumbent President Jokowi seeks to burnish his economic credentials and defend his record. We can, therefore, expect heightened protectionist rhetoric from both candidates and a shift away from the more liberal direction that President Jokowi had been heading as we head into what will be a closely fought election.

Global Business Guide Indonesia - 2018

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)

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