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Bank Indonesia May Raise Deposit Facility Rate, Sarwono Says

Bank Indonesia Deputy Governor Hartadi Sarwono
Hartadi Sarwono, deputy governor of Bank Indonesia. Photographer: Dimas Ardian/Bloomberg

Bank Indonesia may gradually raise the rate it pays lenders on overnight deposits while keeping the benchmark unchanged, Deputy Governor Hartadi Sarwono said, signaling the need to boost short-term borrowing costs as the rupiah declines.

“There’s a possibility that the Fasbi rate will be gradually increased,” Sarwono said in a Nov. 9 interview at the central bank in Jakarta, referring to the deposit facility rate. “There’s no pressure to change” the main reference rate in the next three to six months, because it is still “consistent” with the inflation target, he said.

Indonesia has kept its benchmark interest rate unchanged at a record-low 5.75 percent for nine meetings, refraining from joining neighbors from Thailand to the Philippines in extending monetary easing as growth exceeding 6 percent reduces the need for stimulus. At the same time, rising imports have spurred a current-account deficit and weakened the rupiah, prompting the central bank to intervene to limit exchange-rate fluctuations.

The central bank needs to look more closely at the Fasbi rate because exporters may not want to sell their dollars to finance their domestic business when they can borrow cheaply on the rupiah market, Sarwono said. His biggest concern is the day-to-day volatility of the currency that may hurt investor confidence, rather than growth or inflation, he said.

Rupiah Falls

The rupiah fell 0.2 percent to 9,635 per dollar as of 1:48 p.m. in Jakarta, prices from local banks compiled by Bloomberg show. The currency lost 0.1 percent last week.

“We don’t have to overreact in our policy implementation but managing day-to-day liquidity is important,” Sarwono said. “We don’t want to choke economic activity because this is only a short-term problem, not a medium- and longer-term problem.”

Bank Indonesia raised the deposit facility rate in August to 4 percent from 3.75 percent, even as it has left the key reference rate unchanged since a cut in February.

The Fasbi rate is “in many ways more important” than the reference rate because it represents the floor for interbank borrowing costs, Jens Lauschke and Eugene Leow, analysts at DBS Group Holdings Ltd. in Singapore, said in an August report. Lenders have no incentive to loan to other banks at levels below what they can earn at Bank Indonesia, so Fasbi rate changes can have “significant impact” on interbank rates and the rest of the yield curve, they said.

Monetary ‘Looseness’

Economists from Bank of America Corp. and HSBC Holdings Plc are among those predicting the central bank will raise the deposit facility rate by 75 basis points in coming months. The rate will reach 4.75 percent by the middle of 2013, Chua Hak Bin, an economist at Bank of America, said in a Nov. 8 report.

“Given the ongoing looseness of monetary settings and the robustness of domestic indicators, we think the central bank still needs to work at keeping domestic demand - and hence import pressures - contained,” Lim Su Sian, an economist at HSBC, who sees scope for three 25 basis-point increases in the Fasbi rate, said in a Nov. 8 research note.

Indonesia’s currency has fallen about 6 percent against the dollar this year, the biggest decline among the 11 most-traded Asian currencies tracked by Bloomberg.

Currency Outlook

The currency probably won’t weaken further and will start appreciating as the current-account shortfall narrows and the capital-account surplus improves, Sarwono said. The decline this year was because of the current-account deficit and the central bank didn’t try to prevent the drop, he said.

“We don’t use a depreciation policy to support exports so we just let the fundamentals of the economy dictate the movement of the exchange rate,” he said. The current exchange rate of about 9,600 rupiah a dollar is “still consistent with the fundamentals and it will move back to an appreciation trend” when uncertainty over the global economy abates, he said.

The current-account shortfall in the third quarter narrowed to 2.4 percent of GDP, or $5.34 billion, from 3.5 percent in the second quarter, the central bank said last week, citing a recovery in the trade balance as consumption goods imports ease. The balance of payments last quarter was a surplus of $834 million, and that may increase as the capital account is boosted by foreign direct investment, it said.

The rupiah’s movement is still in line with market conditions, and the intensity of the depreciation is easing, Bank Indonesia said last week. The currency’s one-month implied volatility, which measures exchange-rate swings used to price options, has fallen to 4.80 percent, the lowest level since September 2008.

‘Thin’ Market

“The problem is our market is very thin in Indonesia,” Sarwono said. “There’s a short supply because exporters don’t want to sell their dollars or commercial banks are keeping their money in term deposits.”

While the central bank steps into the market to provide enough liquidity from time to time, the intervention may not be as big as before and isn’t intended to change the level of the exchange rate, he said.

Indonesia is studying measures to counter any excessive capital inflows due to quantitative easing in developed nations if needed, including adjusting the reserve requirement and using available open-market instruments to absorb excess liquidity, the deputy governor said.

Capital Inflows

“Although Indonesia very much welcomes capital inflows to finance medium and longer-term economic activity, we remain vigilant of the impact of short-term capital reversal, so we have to have ammunition or instruments to reduce the volatility in the exchange-rate market,” he said.

Elsewhere in Asia where currencies have climbed, policy makers have moved to prevent excess funds in the financial system from spurring inflation. In July, the Philippine central bank tightened rules on capital inflows by limiting where foreign funds can put their money.

Bank Indonesia reduced its 2012 growth target to 6.3 percent from 6.5 percent last week while keeping the forecast for 2013 at 6.3 percent to 6.7 percent. Inflation remains manageable and will probably be at the midpoint of the monetary authority’s target range of 3.5 percent to 5.5 percent at the end of this year, it said.

This year’s growth forecast was cut because of uncertainty over the outlook for China and India, with China’s prospects being affected by political developments, Sarwono said. The “baseline” scenario for 2013 is an expansion of 6.5 percent in Indonesia, he said.

Fuel Prices

A planned increase in electricity tariffs and a possible rise in fuel prices may boost cost pressures next year, Sarwono said. Even then, inflation in Southeast Asia’s largest economy will probably not exceed 5.5 percent, he said.

“The fuel price impact will depend on how much they increase but as long as we can mitigate the second-round impact,” the effects will be for a short period, he said.

Fitch Ratings and Moody’s Investors Service have raised Indonesia to investment grade, boosting investments in some of the country’s asset markets. The yield on the government’s 7 percent bonds maturing in May 2022 dropped three basis points, or 0.03 percentage point, to 5.53 percent today, according to prices from the Inter Dealer Market Association. That’s the lowest level since March.

While the faltering global economy has prompted investors to adopt a “wait-and-see” stance, companies aren’t changing overall business plans drastically, he said. “We remain vigilant, we don’t use any drastic policy to alter this situation,” he said, referring to the central bank’s stance.

Deepening Market

The most urgent task for Indonesia in the medium to longer term is to deepen its financial market and provide investors with more avenues to put their money in the country, while helping fund infrastructure programs, Sarwono said. Should the government take steps to boost the capital and corporate bond markets, the central bank will be prepared to ensure liquidity in those areas, he said.

Currently, the central bank can “stabilize” the government bonds with purchases in the secondary market, he said. It can perform a similar role with corporate debt if needed in the future, he said, citing the possibility of a “third-party repo market” with commercial lenders because Bank Indonesia can’t buy company bonds directly.

“We know that investors still want to invest their money but from our side we don’t have papers or instruments to sell to them because government bonds are very limited,” he said. “The budget deficit is very low, below 3 percent, so there’s no intention from the government in this year and next to issue much government bonds, although the investors are there.”

The government is in talks with the Asian Development Bank and the World Bank on instruments to finance the country’s infrastructure projects, he said.

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