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Economy

Further Indonesian rate hikes expected as Fed moves loom

Central bank calls 'economic shocks' in Turkey a new external risk

Bank Indonesia Gov. Perry Warjiyo prepares for a news conference after the central bank's latest rate decision.   © AP

JAKARTA -- Indonesia's central bank surprised the market on Wednesday with a fourth interest rate hike in three months, but with the U.S. Federal Reserve set to continue tightening monetary policy, analysts expect Bank Indonesia to repeat the move in the coming months.

"Today's rate hike... demonstrates that BI's main focus remains supporting the currency," Gareth Leather, senior Asia economist at Capital Economics, said in a note. "With the rupiah likely to remain under downward pressure over the coming months, further rate hikes are likely before the end of the year."

Citing potential spillover from "economic shocks" in Turkey as a new external risk, Bank Indonesia Gov. Perry Warjiyo on Wednesday said the bank decided to raise its benchmark seven-day reverse repo rate by 25 basis points to 5.5%. This makes for a total rise of 125 basis points since Warjiyo took over in May.

Economists say any contagion from Turkey's currency crisis will be limited in Indonesia. Taye Shim, securities analyst from Mirae Asset Sekuritas Indonesia, said investors tend to generalize country-specific risks facing emerging markets.

"We would be careful about broadening Trump-driven risks [like the Turkey crisis] to the broader emerging-market space," Shim said. "Although Indonesia and the other emerging-market economies will likely feel the squeeze, we see a low chance of Turkey risk derailing Indonesia's growth trajectory, given Indonesia's relatively benign fundamentals as well as room for monetary policy response."

However, Indonesia's hiking cycle is unlikely to stop just yet, with the Indonesian central bank expecting the Fed "to continue raising the Fed funds rate gradually." Rising trade tensions between the U.S. and China are also a concern for Bank Indonesia, as they have the potential to weigh on investors' minds and lead to capital outflows from Southeast Asia's largest economy.

The increased global uncertainties, coupled with a widening current-account deficit driven by high import growth, continue to put downward pressure on the rupiah, which reached its lowest level against the dollar since October 2015 earlier this week. The rupiah has fallen by more than 7% against the dollar since the start of the year, making it one of the worst performers in the region, despite the central bank's previous hikes.

Citing Warjiyo's "hawkish rhetoric," Nomura forecasts another 25-basis-point increase by Bank Indonesia next month, when the Fed is also expected to raise rates. David Sumual, chief economist at Indonesia's largest private lender, Bank Central Asia, forecasts BI to hike the rate to 5.75% or 6% by the end of this year.

The rupiah strengthened slightly after Bank Indonesia's latest announcement, and the government has announced it will introduce "drastic" measures to curb imports and widening trade deficits, including a higher import tax on "nonstrategic" capital and consumer goods, as well as delays on some infrastructure projects requiring high import content. But analysts see the currency remaining in a vulnerable state.

Rupiah depreciation could hurt President Joko Widodo's re-election chances by driving up consumer prices, but the central bank predicts inflation to remain within the 2018 target range of 3.5%, plus or minus 1 percentage point.

"With global risk sentiment still tepid amid lingering concerns from Turkey, a focus on current-account deficit currencies and [developed market] policy normalization, we believe further [rupiah] depreciation cannot be ruled out," Nomura said.

Jameel Ahmad, global head of currency strategy and market research at FXTM, similarly said that rupiah can still suffer further weakness as a result of "limited" investor appetite for buying emerging-market currencies.

Bank Indonesia on Wednesday revised its economic growth projection for 2018 down to a range of 5.0% to 5.4% from a range of 5.1% to 5.5%.

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