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Indonesia raises interest rate for 1st time since 2014

Central bank's decision follows that of other Asian nations amid rupiah's slide

Bank Indonesia wants to shore up the rupiah to prevent living costs from rising in the run-up to elections. (Photo by Ken Kobayashi)

JAKARTA -- Indonesia's central bank has raised its benchmark interest rate for the first time in almost four years as it battles to stop the slide of the rupiah against rising U.S. interest rates.

Bank Indonesia on Thursday decided to hike its benchmark seven-day repo rate by 25 basis points to 4.50%, marking the first rate increase since November 2014, when the central bank operated under a different benchmark rate.

The decision comes as the Indonesian rupiah continues to decline against the U.S. dollar. The rupiah has dropped about 4% since the start of the year, touching its weakest level since 2015 on Wednesday as the U.S. Federal Reserve extends its monetary tightening policy.

"The policy is pursued as part of the Bank Indonesia policy mix to maintain economic stability amid continued uncertainty in the global financial markets and decline in global liquidity," the central bank said in a statement. "Bank Indonesia will also continue efforts to stabilize the rupiah exchange rate in accordance with its fundamental condition."

At a press conference after the monetary policy meeting, Gov. Agus Martowardojo said the central bank was staying on its toes as developed nations look to normalize their monetary policy. "BI will keep alert on impacts ... on outflow of funds from emerging economies including Indonesia to the U.S," he said. "If the conditions ask for it, we will have no doubts to do another adjustment to our policy rate."

The rupiah's fall was likely exacerbated by foreign investors selling Indonesian stocks and bonds. According to Societe Generale, sales of stocks by foreigners this year has so far totaled $2.7 billion, while net sales of sovereign bonds hit $1.1 billion last month.

Bank Indonesia used its foreign currency reserves to prop up the rupiah, but with reserves diminishing 5.3% from a record high of $132 billion in January to $124.9 billion in April, the bank had to resort to raising the interest rate.

The move was widely expected after the central bank released a statement last week saying that "rupiah depreciation over the past few weeks is no longer consonant with current economic fundamentals in Indonesia," and that the central bank had "adequate space" to adjust its key interest rate.

"A relatively high level of foreign currency debt, which we estimate is equivalent to around 28% of GDP, makes Indonesia vulnerable to sharp falls in the rupiah," said Gareth Leather, senior Asia economist at Capital Economics. "As a result, the outlook for monetary policy will continue to be dependent on the performance of the currency. We are forecasting further weakness in the rupiah between now and the end of 2018. ... If we are right, then further rate hikes are likely before the end of the year," he added.

The bank had embarked on a series of rate cuts from 2015 through 2017, as President Joko Widodo aimed to facilitate lending and boost growth. But despite the accommodative policy, the economy has been slow to surpass the year-on-year average growth of 5.1% over the past five years.

The latest gross domestic product data also disappointed, showing growth of only 5.06% on an inflation adjusted basis, short of a consensus forecast of 5.18%.

There is now risk that hiking the interest rate may stifle economic growth.

However, the rate rise was necessary, as Indonesia has a high share of imported inflation, particularly from oil exports. According to rating agency Moody's, fuel, electricity and water account for more than 5% of the country's consumer price index. Inflation remains in check, with the April inflation rate at 3.4%, close to the mid-point of Bank Indonesia's target range of 2.5% to 4.5%. But any further weakening of the rupiah would increase inflationary pressures, disrupting the broader price stability seen over the past few years.

With the country heading into elections, the prospect of higher inflation driving up living costs is something the government does not want to risk.

The latest monetary policy meeting marked the end of Bank Indonesia Gov. Agus Martowardojo's five-year term. He will be replaced by Deputy Gov. Perry Warjiyo on May 23.

Bank Indonesia's decision follows that of the Philippines' Bangko Sentral ng Pilipinas, which raised its benchmark overnight lending rate by 25 basis points to 3.25% last week amid rising inflation and the falling peso.

Malaysia's central bank raised its key rate in January for the first time in three and a half years to 3.25% from 3%.

Nikkei staff writer Erwida Maulia in Jakarta contributed to this article.

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