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Bank Indonesia rate cut: Walking against the wind?
As of mid-September, the capital inflow to Indonesia’s financial market especially in government bonds is still robust. Indonesia currently offers relatively high yields compared to neighboring countries.
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Bank Indonesia headquarters on Jl. M.H. Thamrin, Central Jakarta (JP/Wienda Parwitasari)
B
ank Indonesia last week cut its policy rate by 25 basis points in the second such move within one month. This policy aims to strengthen banking intermediation and accelerate economic growth, which has been considered too moderate for rather a long period. This cut was widely unexpected.
A day before, the US Federal Reserve announced that it would stick to its plan to gradually tighten monetary policy.
Hence, the Fed signaled it would hike its key interest rate once again this year. After the press release, a Bloomberg survey showed that 63 percent of market players believe the Fed will increase the federal funds rate in its December meeting, up significantly from the 36 percent who believed so a week before the Fed’s press release.
The Fed also will embark on balance sheet normalization this month, reducing its balance sheet gradually to the pre-crisis level. Former Fed chief Ben Bernanke has predicted that the Fed’s balance sheet is currently around US$4.5 trillion ( before the 2007 global financial crisis it was below $900 billion).
In the first round, the Fed will no longer reinvest monthly principal repayments for maturing Treasury bills and mortgagebacked securities for $6 billion and $4 billion, respectively.
This combined policy will significantly reduce dollar liquidity in the market and drive up yields in the US bond market. Holding US bonds becomes more attractive and liquidity will flow to the US market.
So far this year, the Fed has increased its policy rate twice, and we can observe a massive capital inflow to the US as a result. By August 2017, $172 billion has flown to the US financial market, up significantly from the same period in 2016, when it was only about $71 billion.
