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Analysis: Bank Indonesia’s new seven-day reverse repo rate
At the last board of governors meeting earlier this month, Bank Indonesia (BI) announced the utilization of a new benchmark rate, the seven-day reverse repo rate, which was unchanged at 5
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At the last board of governors meeting earlier this month, Bank Indonesia (BI) announced the utilization of a new benchmark rate, the seven-day reverse repo rate, which was unchanged at 5.25 percent. This was not in line with either our or consensus estimations, both of which forecast a 25 basis points (bps) rate cut.
The deposit facility rate at 4.50 percent was also unchanged, although there was a 100 bps rate cut in the lending facility to 6 percent from 7 percent in July, resulting in the symmetrical spread of 75 bps between the benchmark rate of the lending and deposit facilities.
On future policy guidance, BI stated that there was room for monetary easing, as supported by inflation stabilization, current account deficit improvement and rupiah appreciation against the US dollar. On the ongoing tax amnesty program, BI remains supportive while, externally, the central bank is watching the US Federal Reserve, which is expected to hike rates this year.
BI stated that there were three main goals for the seven-day reverse repo rate utilization. First, strengthening monetary policy signals to financial markets through actively traded seven-day reverse repo instruments. Second, enhancing monetary policy effectiveness to lower bank interest rates. Third, improving financial market deepening, especially for money market rates with three-month to 12-month tenors.
The new symmetrical spread between the benchmark rate to the lending and deposit facilities indicates BI’s neutral stance on banking liquidity, and encouragement of prudent liquidity management for commercial banks. Additionally, the lower lending facility rate should reduce costs of illiquidity for banks and improve lending appetite.
Operationally, the biggest difference between the BI rate and the new seven-day reverse repo rate is on the transaction mechanism, with the latter based on repurchase agreement — at BI’s side — compared to BI rate’s outright-transaction base. BI expects the next monetary operation to minimally impact pricing of government bonds.
BI mentioned that even though the US economy was improving in general, investment remained subdued, and it sees a moderate improvement in the EU economy. Meanwhile, small impact from public spending in China limits growth prospects, while commodity prices experienced a modest
recovery.
On growth prospects, recovery is supported by private consumption and government investment, while expectations of lower government spending realization in the second half should limit the overall gross domestic product (GDP) growth in 2016. Hence, BI cut the 2016 GDP growth forecast to 4.9 to 5.3 percent from 5 to 5.4 percent previously.
We welcome the utilization of BI’s new benchmark rate and the decision to cut lending to the deposit facility as positive for liquidity and loan growth. For the bond market, the unchanged policy rate impact should be neutral as the Financial Services Authority (OJK) recently decided to keep the old BI rate as banks’ deposit rate benchmark.
On the next policy easing, BI indicated that the central bank would be data dependent. At this stage, we expect the implementation of looser monetary policy to materialize as soon as inflation drops toward the lower range of BI’s target of 3 to 5 percent. Thus, we retain our forecast of another 75 bps cut this year for the seven-day reverse repo rate to 4.5 percent.
Failure to do so by BI will mean extremely low inflation ahead and sub-optimal GDP growth for Indonesia. Be warned.
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The writer is an economist at Bahana Securities.
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