Bank Indonesia Surprises on Rates to Boost Rupiah Appeal

Indonesia raised interest rates to the highest level since 2009 to sustain overseas demand for its currency even as it risks hurting growth in Southeast Asia’s biggest economy.

Bank Indonesia is seeking to maintain foreign interest in its assets, which has helped fuel growth and overcome a lack of structural reforms, said Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore and an adviser to former president Suharto during the Asian financial crisis.

Governor Agus Martowardojo, 57, has now mounted his fifth surprise bump in borrowing costs since taking the central bank’s helm in May, accepting slower growth as a price for reining in a record current-account deficit. The rupiah, one of the worst-hit currencies when capital flowed out of emerging markets earlier this year, has fallen 17 percent in 2013.

“They’ve displayed some aggressiveness,” said Hanke, who advised Suharto when the ex-general considered pegging the rupiah to the dollar in 1998. “To some extent you can keep the carry trade attractive, but pretty soon you’re going to end up killing the domestic economy if you raise rates too much.”

In a so-called carry trade, investors make money by borrowing in a country with low interest rates and converting the funds into a currency where returns are higher.

Safeguard Rupiah

Bank Indonesia raised the reference rate by 25 basis points to 7.5 percent, it said in Jakarta yesterday, surprising the 24 of 25 economists surveyed by Bloomberg News who predicted no change. The rate move was aimed at easing the current-account gap and meeting the inflation (IDCPIY) target, the central bank said. Bank Indonesia said it will continue to safeguard the stability of the currency.

The rupiah fell 0.1 percent against the dollar as of 5:30 p.m. in Jakarta, prices compiled by Bloomberg from local banks show, making it the worst performer this year among 11 major Asian currencies tracked by Bloomberg.

“They want to keep the rupiah as stable as they can and try to keep a little ahead of inflation and maybe make the unwinding of the carry trade a little less attractive than it would be otherwise,” said Hanke, who is director of the Troubled Currencies Project at the Cato Institute in Washington.

Indonesian officials are grappling with a depreciated exchange rate, elevated inflation and diminished foreign capital inflows, undermining President Susilo Bambang Yudhoyono’s legacy of economic stability before he steps down next year.

Fundamental Reforms

“They’ve been living off the gift of the carry trade,” Hanke said. “It kind of glosses over the fact that fundamental reforms really have never been implemented,” he said, referring to fuel subsidies, infrastructure gaps and corruption.

Indonesia raised domestic fuel prices in June for the first time since 2008 to cut subsidy costs. In a country where riots spurred by soaring living costs helped oust dictator Suharto in 1998, protests derailed a plan by Yudhoyono to increase fuel prices last year. The energy-producing nation is a net importer of oil.

With yesterday’s move, the central bank has raised its key rate by 1.75 percentage points since early June. Inflation remained above 8 percent for a fourth month in October.

“The move is preemptive and they’re willing to live with lower growth, lower credit growth, lower import growth so long as the current account is at a more manageable magnitude,” said Chua Hak Bin, an economist at Bank of America Corp. in Singapore. “Nine months ago, there were some concerns that BI was behind the curve. They’re also acting to restore their credibility, to preempt further concerns.”

Deficit Priority

The current-account shortfall narrowed to $8.4 billion in the third quarter, or 3.8 percent of gross domestic product, Bank Indonesia said today. That compared to $9.9 billion or 4.4 percent of gross domestic product in the three months through June. One-month rupiah forward prices extended gains to 0.9 percent after the announcement, data compiled by Bloomberg shows.

Narrowing the deficit is the number one priority for Indonesia, and the government is planning a policy package this month to help the balance of payments, Finance Minister Chatib Basri said Nov. 7.

The central bank also raised the deposit facility rate to 5.75 percent from 5.5 percent yesterday.

“With the current-account deficit now essentially a monetary policy target, further tightening to quell domestic demand and stabilize the current-account deficit cannot be ruled out,” said Daniel Wilson, an economist at Australia & New Zealand Banking Group Ltd. in Singapore. “We view this out-of-consensus hike as an important step towards realigning the markets’ view on BI rhetoric and adds further credibility to the new governor’s more prudent approach to monetary policy.”

Growth Drag

GDP increased 5.6 percent in the three months ended Sept. 30 from a year earlier after climbing 5.8 percent in the second quarter, the government said Nov. 6. Bank Indonesia predicts 2013 growth of between 5.5 percent and 5.9 percent, and forecasts an expansion of 5.8 percent to 6.2 percent in 2014.

“The lagged impact of substantial rate increases in the last few months will weigh heavily on growth in coming quarters,” said Krystal Tan, an economist at Capital Economics Ltd. in Singapore. Barring further financial market turmoil, yesterday’s move “is likely to be the last in the current tightening cycle,” she said.

To contact the reporters on this story: Novrida Manurung in Jakarta at nmanurung@bloomberg.net; Rich Miller in Washington at rmiller28@bloomberg.net

To contact the editor responsible for this story: Shamim Adam at sadam2@bloomberg.net

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