ECONOMIC UPDATE - Monetary review
An all out move for Rupiah
Central bank raises 7-day reverse repo rate by 25 bps
Surprising the consensus but in line with our estimates, Bank Indonesia (BI) decided to raise policy rates by 25bps to 5.50% in the May board of governor meeting. It also increased deposit facility rate to 4.75% and lending facility rate to 6.25%. This is the 4th times central bank raises the policy rate this year, totaling 125 bps hike. BI noted this move is important to maintain sustainability and keep the economic resilience
All out for Rupiah which instability affect negatively to investment growth in 2Q18
Bank Indonesia mentioned the importance to keep attractiveness of domestic financial market and manage the widening current account deficit (CAD) through increasing the policy rate. It is even ready to take the risk of sacrificing growth as central bank just revise down the growth target to 5.0% - 5.4% in 2018 from 5.1% - 5.5%. In 2018, Rupiah and other emerging market currencies saw global pressure from FFR hike, trade war escalation and the latest of Turkey Lira crisis. Pre-emptive move of rate hike is seen as necessary to prevent further depreciation of those currencies even though it would not help them appreciate significantly. Major pressure to Rupiah also came from widening current account deficit to 3.04% of GDP in 2Q18. Huge trade deficit in July (see exhibit 4) just worsen outlook of CAD as it may stay near BI’s safe limit of 3% of GDP. Maintaining healthy CAD and stable Rupiah from global volatility will be important challenges for Indonesia to keep the growth momentum. In 2Q18, global volatility and Rupiah depreciation affect appetite for investor investing in Indonesia. Just yesterday, investment board announced that Indonesia’s FDI in USD was down -13.4% YoY, in line with declining investment growth in GDP at 5.87% YoY after posting more than 7% growth in previous 3 quarters (see exhibit 5). Maintaining sustainability of Rupiah will mean to maintain the investment growth momentum in medium – longer term, requiring all out move from both government and central bank to defend it. Furthermore, central bank also stated that it will accelerate financial market deepening through Indonesia new money market benchmark overnight rate (IndONIA), followed by Overnight Index Swap (OIS) and Interest Rate Swap (IRS) instrument development in order to strengthening monetary policy transmission, keeping liquidity in the market and maintaining Rupiah stability in the end.
Lira crisis and Indonesia’s twin deficit
Turkey crisis should give negative sentiment to overall emerging market. Countries that will get hit first are the one who have major challenges in CAD and budget deficit because fundamentally their currency should depreciate. In Asia case, Indonesia, India and Philippines are the most vulnerable because of their twin deficit problems in current account and budget. In 1H18 case has denote the vulnerability of these currencies due to FFR hike and trade war compared to other major currencies in Asia as showed by exhibit 2. CNY, as denoted in exhibit 3, also had major pressure entering 3Q18 due to trade war escalation. The pressure to Indonesian Rupiah, especially, is higher in this week because of the CAD data showed it have break safe limit of 3% of GDP in 2nd quarter. Lira crisis that peaked on Aug 10 due to Trump’s sanction against Turkey just add pressure to Rupiah, pushing BI to raise its policy rates.
We may move towards our pessimistic view if Lira crisis continue and trade war escalate, expecting 25-75 bps rate hike in remaining 2018
Considering current global high volatility and widening domestic CAD, we believe it is very difficult for Rupiah to appreciate back below the Rp14,000/USD again in this year. Investors will remain cautious in 2H18 to buy Rupiah assets. We believe that Rupiah will average Rp 14,300 in 2H18 but should the Turkey crisis not ease and trade war escalate further, we will move to our pessimistic case of Rupiah at Rp14,750/USD in YE 2018. Judging from BI hawkish tone of it is willing to sacrifice the growth to maintain stability; it may still raise the policy rate in the remaining of 2018. We predict another 25 bps rate hike move in remaining 2018 in current condition. However, we do not rule out that 7-day reverse repo rate may hike by another 75 bps should the Lira crisis worsen and trade war escalate.