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BI kept its word

Bank Indonesia left the 7-day reverse repo rate unchanged at 5.75% for a second consecutive month. Policy commentary suggested the decision was forward-looking and pre-emptive, with a multi-pronged approach towards its other goals.

Plans are to step up monetary operations to quicken policy transmission, stabilise the currency through intervention, and also draw more FX inflows by continuing the operation twist mechanism in short-term bonds as well as strengthening the special FX term deposit facility (see details in the next section). 

Economic assessment

BI Governor Perry expressed confidence in global growth prospects but cited the recent banking sector crisis as stoking uncertainty. Yet timely action by the US Fed and European policymakers was expected to stabilise markets. BI’s risk scenario includes a lift in the US Fed rate to 5.25-5.5% in this cycle.

Domestic data markers are encouraging, with growth at the upper end of the 4.5-5.3% range. Despite a lift in Feb headline inflation, the core reading eased, implying much of the increase was due to seasonal effects, i.e., upcoming Ramadan festivities. Core inflation is seen in the 2-4% target range in 1H23, and the headline is expected to return to the range in 2H23. BI Governor Perry also clarified that domestic banks did not face risks like the SVB, and contagion risks were negligible. Banks have cleared stress tests, and bond holdings have been shifted to the HTM (held-to-maturity) portfolio. From 1% of GDP surplus in 2022, the current account balance is expected to range between -0.4% and 0.4% of GDP this year, likely on a narrower commodity-driven trade surfeit.

Outlook

Bank Indonesia left the benchmark rate on hold, signaling confidence on the evolving inflation-growth path. Even as February headline inflation ticked up, the improving core inflation profile supported a pause on rates. Rupiah’s year-to-date outperformance (1.3%/ USD) likely added to the policymakers’ comfort. Our baseline view is for the benchmark rate to be held unchanged at 7% for the coming months. BI Governor Perry reiterated the official view that the current policy stance was appropriate. We reckon that forward-looking policy guidance can build some headroom by reflecting a preference to stay nimble to backstop the currency, in case of volatility in the global FX markets due to repricing in US rate expectations, lingering uncertainties, and strains in the US/Europe banking sectors.

Credit growth, liquidity, and export earnings policy

Banks’ credit growth is off its peak, with yoy readings to be partly capped by base effects, with Feb23 at 10.6% yoy.

Nominal credit growth averaged 9.3% last year vs 0.4% in 2021. Near-term moderation is likely driven by slower uptake for working loans by the industrial sector as well as investment loans.

Aggregate rupiah lending rates also bottomed out in 3Q22 and have since been gradually inching up across end-purposes, including working capital, investments, and consumption. At the same time, the lending deposit ratio (LDR) has slipped back below 80% by end-2022 from 82.4% in Sep22. While last year’s level was already below the pre-pandemic highs, this pullback lowers the incremental squeeze on liquidity.

Banking system liquidity is thereby in a comfortable surplus, in turn lowering pressure on the institutions to raise deposit rates in a hurry. The aggregate rate on saving accounts has not risen materially since last year, while (on aggregate) term deposit across tenors (1M to 24M) are up by an average ~100-130bp. With flush liquidity, pressure on banks to raise funds to fund incremental loan growth is also lesser. While moderation in yoy lending growth rate is partly a function of base effects, slower growth is also a sign of normalisation in post-pandemic activity as well as the tapering input costs that easing working capital demand.

Lastly, four tranches of the special FX term deposit scheme, under the export earnings policy, attracted a cumulative $173.05mn to date, all in the one-month tenor. Preference for the shortest tenor available is likely indicative of the uncertainty that clouds the US rates outlook as well as upward revisions in the offshore dollar deposits following gains in the US yields earlier in the month.

If these term deposits gain traction, this will help further boost the economy’s reserves and backstop the central bank’s efforts to keep the currency stable during pockets of uncertainty. 

As of Feb-23, foreign reserves stood at $140.3bn, equivalent to 6.2 months of imports or 6.0 months of imports as well as external debt servicing needs, well above minimum thresholds. Our gross external financing ratio for Indonesia is also comfortable given successive current account surpluses, stable short-term debt, and firm reserves position

 
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