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ECONOMIC UPDATE - Monetary Review - Tends to tightening bias

ECONOMIC UPDATE - Monetary Review

Tends to tightening bias


Second rate hike within two weeks

Bank Indonesia (BI) decided to raise its policy rate by another 25bps to 4.75% in the extraordinary board of governor meeting today. It also increased deposit facility rate to 4.00% and lending facility rate to 5.50%.


Pre-emptive, front-loading and ahead of the curve

In its statement, central bank sees the rate hike as pre-emptive, front-loading, and ahead of the curve in order to stabilize Rupiah and consistently maintain inflation target at 3.5% +/- 1%. BI mentioned 3 global factors as the main reasons behind Rupiah and other currencies depreciation: 1) Shifting FFR expectation to 3-4 times, 2) US budget deficit which is predicted at 4% of GDP in 2018 and 5% of GDP in 2019 and 3) geopolitical conflicts. Moreover, BI sees current Rupiah depreciation is overshoot, making current value is far below its fundamental. Rate hike is a part of short term stabilization policies, especially regarding Rupiah. Second policy for stabilization is dual intervention where central bank will intervene through currency and bonds market. The next policy is maintaining Rupiah and forex liquidity through money market and interbank swap market. BI also tries to maintain intensive communication with market, banks, business and economists to keep rational expectation and mitigate overshooting Rupiah depreciation compared to its fundamental value.


Rate hike effect to growth will not as significant as widely predict

Bank Indonesia many times stressed out that rate hike will not affect loan growth and economic growth significantly. Moreover, it does not see necessity of banks to increase their deposit rate and credit rate. BI emphasized 3 main reasons of why rate hike will not affect deposit and credit rate and also loan growth in the end. First, central bank will ensure liquidity is enough in the market. Enough liquidity will prevent banks to compete in raising deposit rate for attracting funds. Second, loan demand is still below its potential and economy still need low credit rate to stimulate demand. Third, last year rate cut is still not fully reflected in current credit rate, making the current credit rate should not follow the uptrend of rate hike. Furthermore, BI will announce accommodative macroprudential policy in June to stimulate loan and economic growth, especially in housing and property sector. BI is still confident of double digit loan growth in 2018. Furthermore, it sees 2018 economic growth will be around 5.2% with 3.6% inflation and fewer than 2.5% of GDP current account deficit (CAD).


Current policy stance: tend to tightening bias, signaling another rate hike in near future

BI hawkish tone has been seen since Rupiah exceeded Rp 14,000 level. BI new governor, Perry Warjiyo, restated BI hawkish tone in the latest BoG meeting by saying BI is on “tend to tightening bias mode”. Furthermore, he said central bank will calibrate further economic and finance development to utilize room for “measured rate hike”. It is a clear signal that BI still open chance for another rate hike in near future. Future monetary policy will be data dependent and according to BI’s statement, it pointed out inflation, CAD, FFR and US treasury yield data as its main concern. Perry stated BI predicted inflation at 3.6%, CAD at below 2.5% of GDP and FFR hike at 3x while it is not clearly stated its prediction of UST 10 yr yield. Our estimation is in line with BI (3.5% inflation and 2.1% of GDP CAD), except for FFR hike estimation where we estimate 4x hike in 2018. Current economists estimate is back again to 3x FFR hike in 2018 (see exhibit 3) due to dovish May FOMC meeting minutes but we still believe FOMC projection in June will reveal 4x FFR hike in 2018 and 2x in 2019 and will trigger BI to tighten its policy even more. We believe that BI will raise BI 7 days reverse repo rate (7DRRR) by 25 bps to 5.00% in June BoG meeting. Our assessment sees current bond yield is still priced in only to 2 x BI 7DRRR hike. Further hike will make us to revise our bond yield estimation. We will review our Rupiah and bond yield in our next monetary review.