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Economy

Bank Indonesia lowers policy rate to 4.5%

Surprise cut -- the first in 10 months -- is driven by 'alleviated' Fed risks

Bank Indonesia Governor Agus Martowardojo speaking at the central bank's headquarters in Jakarta in May.   © Reuters

JAKARTA -- In a move that surprised many, Bank Indonesia on Tuesday said it will cut its policy interest rate by 0.25 percentage points to 4.5% to stimulate the economy in the wake of slower-than-expected second-quarter growth.

After cutting its policy rate six times in 2016, the central bank hit the brakes on easing from October in anticipation that the U.S. Federal Reserve will start to raise interest rates. But inflation and the rupiah-dollar exchange rate have remained largely stable, prompting the central bank to switch back to stimulating the economy. Gross domestic product grew 5.01% in the year for the April-June quarter, matching first-quarter growth and lower than analysts' estimates of 5.1%.

"External risks related to the federal funds rate have been alleviated ... so we think the Indonesian interest cut will be quite attractive," Bank Indonesia Gov. Agus Martowardojo said at a press conference on Tuesday. He expects the U.S. federal funds rate to be hiked only one more time this year -- at the end of 2017 -- instead of twice as he previously predicted.

Domestic credit growth has been weak despite the six rate cuts last year. Martowardojo said that credit had grown less than 3% year-to-date as of June. Bank Indonesia has downgraded its projection for credit growth for this year to 8-10% from 10-12%.

"The rate cut is expected to strengthen the banking sector's intermediation ... therefore fueling more credit disbursement next year," said another Bank Indonesia official.

Indonesia is the latest to join a string of emerging markets that have cut interest rates in the past few weeks, including Brazil, India and South Africa. The trend reflects growing confidence among emerging markets about capital outflows, as market participants increasingly believe that the Fed's monetary tightening will happen at a gradual pace.

Still, Indonesia's budget and current account deficits have made the country vulnerable to capital outflows in the past. In the recently proposed budget, the government plans to lower its budget deficit in 2018 to around 2.2% of GDP.

Another issue is the effectiveness of monetary policy. Local banks have been hesitant to lower their lending rates in the face of a sluggish economy, even after last year's string of policy rate cuts. Some see the central bank's move -- which only one in 20 analysts polled by Reuters expected -- as merely a gesture to lift sentiment.

Gareth Leather, senior Asia economist at Capital Economics, said he expected one more rate cut this year. "The timing and pace of further cuts will be dependent on the performance of the rupiah against the US dollar," he added.

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