Bank Indonesia’s explicit FX stability mandate, rather than inflation, has been the driver of its rate actions in the past year. Benchmark rates were left unchanged at 6.25% yesterday for a second consecutive meeting, after a 25bp hike back in April. Domestic inflation has been moderating, with May’s down to 2.8% yoy, nearing the mid-point of the BI target, vs 3% month before and core at 1.9% yoy. The IDR however depreciated 2% this month (-6%+ ytd), after a brief reprieve in May. Apart from seasonal factors in 2Q and narrow rate differentials vs US, indications of a departure from a longstanding policy of fiscal conservatism has also impacted the view on the currency. The incoming President had suggested that fiscal deficits were unlikely to be constrained by the 3% of GDP threshold and was cited, more recently, saying that public debt might be gradually levered up to 50% of GDP (vs current 39%) in a phased manner. While there have been mixed signals from officials in the run-up to the official inauguration in October, markets are positioned for the risk of lower fiscal prudence by the incoming administration.
BI Governor Perry acknowledged that these risks have troubled the currency but retained his view that USDIDR will return to sub-16000 as more clarity emerges, which would then pave the way for rate cuts. In the interim, there is limited choice but for the authorities to defend the currency via intervention efforts and foreign inflows into OMO instruments (SRBIs). The incremental increase in the FX reserves in May provides more room to defend the currency, after four consecutive months of reduction in the stock. Markets will look to the mid-August’s release of the draft 2025 Budget, where we expect the deficit to stay within the indicated -2.5%-2.8% of GDP (vs -1.7% in 2023) range. We retain our baseline view for status quo on rates this year but assign a small probability for hikes if pressure on the currency mounts.
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