Snapshot BI Rate August 2014

Remains on Hold for Nine Consecutive Months

BI Policy Review

       In the Board of Governors’ Meeting on August 14, 2014, Bank Indonesia decided to maintain BI rate at 7.50% (in line with our forecast). The policy is consistent with the inflation target to 4.5 ± 1% in 2014 and 4.0 ± 1% in 2015, as well as lowering the current account deficit to a more healthy level. Bank Indonesia to assess the process of adjusting the economic structure towards a more balanced still continues to be supported by the maintaining of macroeconomic stability. This is reflected in domestic demand and inflation is restrained in a downward trend, although the current account deficit increased partly due to the seasonal pattern of the second quarter of 2014 Looking ahead, there are a number of external and domestic risks to look out for that may interfere with the achievement of the inflation target and improvement in the current account. Therefore, Bank Indonesia will continue to strengthen monetary and macro prudential policy mix and structural policies to strengthen the domestic economy and the management of foreign debt, especially foreign debts of the corporation. Bank Indonesia will also improve coordination with Government policy in controlling inflation and the current account deficit to the economic adjustment process can be run either by maintaining a sustainable economic growth in the future.

       On the domestic economic growth continued to be moderate in Q2 2014. Overall, the deceleration of growth was driven by all sectors in this section. External sector performance remained weak, determined by relative high trade oil deficit and weakening exports of coal and minerals. On the other side, domestic consumption grew on the slower pace as the consequences of government’s postponement to realize 13th salary disbursements to its ministries and institutions. Investment growth, especially for machine and equipment from overseas, also slowed as investors tended to take wait & see action during the general election period. On the supply side, manufacturing sector, especially on the food, beverages and tobacco sub-sector, improved as the result of election and Ramadan festival preparation. Therefore Indonesia's economic growth reached 5.12% y-o-y in 2Q 2014 or slowed compared to 5.22% y-o-y in 1Q 2014. Overall, we expect the Indonesian economy is only growing at about 5.20% in 2014 (revised down from 5.40% in the previous projection), slowing from 5.78% in 2013.

       In line with the performance of the external sector, Indonesian balance of payments (BOP) improved in the second quarter of 2014 although the current account deficit increased. The balance of payments recorded a surplus of capital and sustained financial performance. Current account deficit in the second quarter of 2014 to reach USD9.1 billion (4.27% of GDP), down from a deficit in the second quarter 2013 amounted USD10.1 billion (4.47% of GDP) in line with the stabilization policy pursued by the Bank of Indonesia and the Government, although the increase of the deficit in the first quarter of 2014 amounted to USD4.2 billion (2.05% of GDP) in line with the seasonal pattern. The increase in non-oil trade balance surplus has not been able to offset the increase in oil and gas trade balance deficit. Meanwhile, interest payments on foreign debt and repatriation of dividends / coupons which increased as a result of seasonal patterns in the second quarter helped push the pressure on the current account deficit. Overall, we expect the current account deficit of -2.90% per GDP in 2014.

       Rupiah appreciated by 3.2% against USD in Jul’14 as presidential election result met market expectation and controlled political stability post election. However, foreign inflows continue flowing to Indonesia capital market. In the stock market, foreigners booked net-buy of USD 1125.4 million in July 2014 while latest data showed foreigner booked net buy in bond market during the month of July by adding up IDR 8.44 trillion. Later, Indonesia's foreign reserves in July 2014 reached US$ 110.54 billion increase from US$ 107.68 billion in June 2014. In addition, increasing foreign reserves was mainly derived from the issuance of Euro Bonds and foreign exchange earnings from exports of oil and gas that exceed government spending on foreign debt payments.

       Indonesia’s money supply (M2) in Jun’14 posted faster growth to 13.1% y-o-y from 10.5% y-o-y in May’14, driven by increasing quasi money. Quasi money recorded growth increased from 10.3% y-o-y in May 2014 to 14.0% y-o-y in Jun’14.Credit in Jun’14 grew slower at 16.6% y-o-y, down from 17.4% y-o-y in a month earlier. The credit slowdown signals a slowing in the domestic economy.

Market Implication

FX Markets

As expected, BI rate is kept unchanged at 7.5% by the central bank today. With BI left the policy rate, it will have little impact on rupiah. Effect of an increase in the current account deficit (CAD) in 2Q 2014 to USD/IDR is also relatively small. This is due to the increase in CAD is still in the range of market expectations. In addition, the increase in CAD can also be offset by increased capital flows (portfolio and direct investment) that impact on Indonesia's balance of payments surplus which increased the foreign exchange reserves. Nevertheless, investors are still waiting and looking at the results of the Constitutional Court's decision related to the results of the presidential election in the next week.

Bond Markets

Although Bank Indonesia left its reference rate unchanged today, we expect that it will have minor impact on the movement of IDR Government Bond (IDR GB). Similarly, with an increase in CAD are still in the range of market expectations and Indonesia's balance of payments is in surplus, will be giving sentiment slightly positive for the Indonesian bond market. However, investors are still waiting and looking at the results of the Constitutional Court's decision related to the results of the presidential election in the next week.