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BI hikes

Decision and economic assessment

Bank Indonesia hiked the policy rate today by 25bp to 6.25%, in line with our off-consensus call. We view this as a move to instil confidence and build in a higher real rate advantage in favour of the currency. The ID-US spread on the benchmark rate was tight, alongside ID-US 10Y gap at ~210-240bp, half of the pre-pandemic range. Add to this, further near-term dollar strength remains on the table on the likelihood of the US dot plot shifting towards two rate cuts next month and additional drip of strong US data in the interim. Domestic inflation is also likely to inch up further to the higher end of the BI’s target of 1.5-3.5% range on higher food, necessitating a hawkish stance.

In his commentary, BI Governor Warjiyo remarked that the US Fed Funds rate may stay higher for longer, trimming the baseline assumption to one rate cut in 2024 from two earlier. Assessment on domestic conditions was balanced, expecting growth to be in the 4.7-5.5% range and inflation within target despite the recent stickiness in headline prints. Signaling limited impact on the real economy from higher rates, 1Q24 loan growth was firm at 12.4% yoy and pegged at 10-12% this year, up from aggregate 9.2% yoy growth in loans of commercial & rural banks in 2023. The current account balance is, however, expected to slip into a deficit of -0.1-0.9% of GDP (DBSf -1.5%) this year from -0.1% in 2023.

Outlook

Despite a let-up in rupiah depreciation this week, we view the hike as a prudent and pre-emptive, as global cues and domestic catalysts are less than conducive (discussed in the next section). Rupiah is expected to stay stable at 16200/USD in 2Q, before easing to 15800 by end-year according to the BI estimates. While a modest hike is not a panacea for the rupiah, we expect the central bank’s proactive hike to backstop the currency. Considering the revised BI’s baseline assumption for the US Fed rate cycle, preference to stay vigilant and prioritising rupiah stability, we expect the BI to stay on an extended pause for rest of the year, assigning a 30% probability of a follow-up hike if conditions so warrant.

Unfavourable cues; potential policy responses

Bank Indonesia has been steadfast in managing rupiah stability. While the possibility of further rate hikes remains on the table, the response framework might include sterilised intervention, bond purchases, drawing inflows at the shorter end of the curve and calling on state owned enterprises to optimize/ restrain their sizeable dollar purchases. A strong intervention presence has pushed down the foreign reserve stock by $6bn in 1Q24, after climbing by $9bn in 2023. The bias to keep the short-term/ open market operations rate high to draw in foreign flows is also bound to continue, with the return on SRBIs drifting up since Feb24 (see chart) and markedly higher than the rate on offer when the instrument was introduced in Sep23.

Apart from a bid dollar and unfavourable external cues, domestic catalysts have also been less favourable for the currency

For one, the trade goods trade surplus has narrowed considerably. March trade surplus registered a sharp improvement to $4.5bn vs $0.8bn month before as the pre-festive import demand dissipated, and nominal exports ticked up slightly. 1Q24 trade surplus is, nonetheless, still 40% down compared to the year ago. This is likely to widen the 1Q24 current account balance to -1.0% to -1.3% of GDP from -0.4% in 4Q23. Secondly, private sector continued with its debt repayments in early-2024 after easing up in late 2023 (see next chart). In 2022, the public sector external debt fell between quarters through the year.

Lastly, the debt market has faced foreign selling on year-to-date basis, with the share of foreign holdings in outstanding IDR bonds slipping below 14% this month. A bigger share of domestic institutions, including banks, have been an important backstop, yet persistent foreign selling has drawn the BI back in to purchase bonds, as part of one of the ‘triple intervention’ legs.

We don’t view the recent rupiah depreciation as overdone. To some extent, the IDR is playing catch-down with its regional peers after few years of relative outperformance and stability. With further near-term dollar strength still on the table, we expect the central bank to stay focused on IDR stability, with intervention still the first line of defence.

Discussion on the 2025 Government Work Plan (RKP) kicks off

The government kickstarted the discussion on the 2025 Government Work Plan (RKP). The RKP assumes additional importance as it also marks the first year of the 2025-2029 National Medium-Term Development Plan (RPJMN), which is a strategic medium-term framework, feeding into the broader 2025-2045 National Long-Term Development Plan (RPJPN).

We recall that the long-term vision reaching ‘Golden Indonesia 2045’ is to make Indonesia's per capita income reach $30,300, with zero poverty and reduced inequality as well as a Human Development Index of 0.73. The draft of the 2025 RKP includes:

• Plans to establish a National Revenue Authority with the aim to boost the country’s tax to GDP ratio to 11.2-12% of GDP in 2025 from 2024 target of 10.1%
• Higher revenue generation is expected to be driven by restructuring tax institutions, implementing core tax system, strengthening tax extensification & supervision on high wealth individual taxpayers, better targeting tax incentives to stimulate priority sectors (agriculture, manufacturing, tourism, and MSMEs)
• Key economic assumptions, include targeting 2025 growth at 5.3-5.6%
• Boost FX reserves to $149.5bn to $153.7bn in 2025 vs 2024 target of $147bn.
• Target merchandise the goods trade surplus of $43.4bn—$43.9bn and the services trade deficit within $15bn—$16.2bn. regarding the other current account components, the primary income deficit was targeted within $36.7bn—$37.5bn, while the secondary income surplus would be within $5.6bn—$5.9bn, according to the local press
• Poverty rate is targeted at 7-8% (vs Mar23’s 9.4%), besides Gini ratio of 0.379-0.382

These goalposts are likely to get a relook when the incoming President officially takes office in October 2024. We view these objectives as milestones to reach the long-term goal for the country. Besides indications of higher social spending by the incoming government, it will also be crucial to embark on measures to expand its manufacturing footprint beyond the resource industries and stay infrastructure focused to boost growth towards 6-7% from the average 5% in 2023-2024 (forecast).


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