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Indonesia holds key rate as trade war hammers rupiah

Central bank bucks trend of monetary easing in Southeast Asia

The Indonesian rupiah has fallen 4% from a year-to-date high in early February. (Photo by Ken Kobayashi)

JAKARTA -- Indonesia's central bank kept its key interest rate unchanged as the recent escalation in trade tensions between the U.S. and China has pushed down the rupiah.

Bank Indonesia on Thursday held its seven-day reverse repo rate at 6% for the sixth straight meeting, bucking a trend that saw Southeast Asian peers in Malaysia and the Philippines cut benchmark rates last week. All 20 economists surveyed by Reuters expected no change in Indonesia's policy.

"The main cause of weakening rupiah is the global uncertainty, especially the escalating trade war between U.S. and China," Bank Indonesia Gov. Perry Warjiyo told reporters after the decision. The governor added that the bank "will strengthen" stability measures through interventions in the financial markets.

The rupiah has been hit in recent weeks by worsening investor sentiment toward emerging-market assets. Indonesia's persistent current-account deficit also makes its currency an easy target for global market players.

The currency has now reversed gains against the dollar earlier this year on the back of tighter monetary policy -- Bank Indonesia raised the benchmark rate by 175 basis points in 2018. The appreciation was also supported by government measures to reduce the trade deficit, an underlying source of pressure on the currency.

The central bank previously estimated the country's current-account deficit to be contained to 2.5% of gross domestic product this year, but Warjiyo said it has had to revise that forecast to a range of 2.5% to 3% as "it is getting very hard" for exports to drive the economy because of the U.S.-China trade spat. The governor also added that Bank Indonesia now expects this year's economic growth to come in toward the lower end of its 5% to 5.4% forecast.

"Earlier this year, it was clear that Bank Indonesia officials were comfortable signaling that rates were near their peak, hinting at possible easing this year," Joseph Incalcaterra, ASEAN chief economist at HSBC said in a report. "With slowing growth, subdued inflation, and a tangible narrowing of the current-account deficit in 1Q, domestic variables suggest easing is warranted."

However, "with the abrupt return of risk-off sentiment this week, alongside U.S.-China trade tensions and an uncertain global growth outlook, we believe Bank Indonesia's focus will pivot back to preventing outflows and maintaining financial stability," the economist added.

Indonesia's trade deficit of $2.5 billion in April, its first in three months and the biggest since July 2013 according to data from FactSet, also has been a drag on the currency.

The rupiah hit 14,463 to the dollar on Thursday, its weakest since early January, and down 4% from a year-to-date high in early February. However, the central bank governor added that Bank Indonesia "will remain open for accommodative monetary policy" as long as economic indicators like inflation shows room for policy adjustment.

The fall in the currency comes despite the country not being directly affected by the global trade tensions.

Research published by Japan's Research Institute of Economy, Trade and Industry noted that the impact on Indonesia from a potential drop in Chinese exports is "relatively muted, given its low participation in Chinese-led global value chains."

Malaysia last week cut its key rate for the first time in nearly three years, making it the first economy in Southeast Asia to ease policy after last year's round of tightening. The country's central bank cited "signs of tightening of financial conditions" for the move.

The Philippines' central bank was also forced to act last week as the economy in the first three months of the year expanded at its slowest pace in four years.

"We think it's too soon to pencil in rate cuts [for Indonesia] given the country's large current-account deficit, which makes the currency vulnerable to sudden falls during periods of weak risk appetite," said Franziska Palmas, assistant economist at Capital Economics, adding that the country's large April trade deficit "suggests that the current account is likely to remain a source of vulnerability this year."

Nikkei staff writer Ismi Damayanti contributed to this article.

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