Indonesia Signals No More Rate Cuts as Inflation Risks Rise

Updated on
  • Central bank holds interest rate at 4.25% as forecast
  • Assistant governor says window for more rate cuts is closing

Indonesia’s central bank signaled the end of monetary policy easing as it focuses on inflation risks, such as rising food and oil costs.

After keeping the benchmark interest rate at 4.25 percent -- as forecast by all 24 economists surveyed by Bloomberg -- Assistant Governor Dody Budi Waluyo indicated there’s limited room for rate cuts after eight reductions in the past two years.

“The monetary stance remains neutral,” he said in Jakarta on Thursday. “We will bring inflation to meet the target of 3.5 percent. Future risks remain, but we see the window for cutting rates is closing.”

Economists are split on whether Bank Indonesia will cut, hold or raise interest rates this year. The bank has been on hold since October, and while it’s still concerned by lackluster credit demand and economic growth that’s stuck at about 5 percent, it’s guarding now against higher inflation -- in particular rising food costs, with rice gaining 6.1 percent in the past two months.

Cost Pressures

Rice prices have risen 6.1 percent in the past two months

Source: Bank Indonesia

* Prices in rupiah per kilogram

The central bank sees inflation as a risk in 2018, but forecast it will remain within the target band of 2.5 percent to 4.5 percent. Economists surveyed by Bloomberg predict inflation will average 3.8 percent this year and next, the same pace as in 2017. Consumer prices rose 3.6 percent in December from a year earlier.

To spur credit growth, which was at 7.5 percent in November, the central bank lowered the amount of deposits that lenders must hold as reserves on a daily basis to 4.5 percent from 5 percent. Banks will still be required to maintain an average reserve ratio of at least 6.5 percent over a two-week period. 

‘Shallow’ Demand

David Sumual, chief economist at PT Bank Central Asia in Jakarta, said the impact of the changes to the reserve ratio requirement will probably be muted.

“It will not help much in boosting the credit as long as the demand for credit is still shallow,” he said. “It will only give flexibility for the banks in managing liquidity -- strengthening their liquidity management -- from a short-term horizon to a longer one.”

The central bank expects loan growth to pick up this year to 10 percent to 12 percent, while the economy will improve, supported by a pick-up in household consumption and stronger exports, Waluyo said.

Frederico Gil Sander, the World Bank’s chief economist for Indonesia, said the challenge for the central bank was to improve the transmission of monetary policy, since lower interest rates haven’t boosted credit demand.

“We do think that the monetary policy stance is adequate,” he said in an interview in Jakarta on Friday. It’s been important for Bank Indonesia to focus on the transmission mechanism “rather than necessarily the policy rate,” he said.

What Our Economists Say...

Indonesia’s central bank is unlikely to cut its policy rate further this year. Bank Indonesia is sounding more confident about the growth outlook, both foreign and domestic. It is also set to loosen reserve requirement rules in July and October. This should support lending and further improve the transmission of monetary policy.

-- Tamara Henderson, Bloomberg Economics

Other key points from the monetary policy statement:

  • Growth estimate for 2018 maintained at 5.1 percent to 5.5 percent
  • Daily minimum primary reserve ratio for Islamic lenders set at 3 percent with two-week average of at least 5 percent

The rupiah rose 0.4 percent to 13,297 per dollar as of 1:15 p.m. in Jakarta. The currency has gained more than 2 percent this month, among the best performers in Asia.

— With assistance by Karl Lester M Yap, Eko Listiyorini, and Chris Bourke

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