BI projects that stronger consumer spending and stable investment will strengthen domestic demand, which underpins national economic growth.
uoyed by stable, low inflation, but concerned over the lower-than-expected economic growth (5.05 percent) in the second quarter and the global economic downturn, Bank Indonesia (BI) decided last Thursday to lower its benchmark seven-day reverse repo rate by 25 basis points to 5.5 percent, deposit facility rates by 25 bps to 4.75 percent and lending facility rates by 25 bps to 6.25 percent.
The accommodative policy stance will help maintain economic growth amid global economic uncertainty and rising protectionist trends. This and the progrowth fiscal plan next year, combined with the faster pace of structural reforms, will strengthen economic resilience.
The policy rate cut was widely predicted by most analysts as BI, for its part, had signaled last month after making the first 25-basis point cut to 5.75 percent since September 2017 that it would adopt an accommodative stance while simultaneously seeking to maintain inflows. The central bank also reiterated that the monetary operations strategy remains oriented toward ensuring adequate liquidity and increasing money market efficiency, thus strengthening the transmission of the accommodative monetary policy.
Good coordination between the monetary and fiscal authorities is essential now to maintain economic stability and catalyze domestic demand while boosting foreign capital inflows, including foreign direct investment, to support external stability.
Given minimal inflation risks, we think BI still has ample room to slash rates and boost growth through investment, with the assumption bond yields will continue declining as a result of the synchronized easing wave among global central banks. Several analysts even foresee another 25 bps cut in the BI policy rate for the rest of 2019. At that level the interest rate differential will still be attractive enough to woo portfolio capital inflows.
But to allow for deeper rate cuts, BI may have to wait for a significant improvement in the current account deficit toward the lower end of its 2.5-3 percent projection. The space for a rate cut will even broaden if President Joko “Jokowi” Widodo is able to gain strong political support for the vigorous acceleration of reforms he has often promised for his second term starting in October.
The central bank reiterated that trade-related tensions are likely to keep the external sector subdued and put pressure on the current account balance. However, BI expects direct and portfolio investment to keep the overall balance of payments stable.
We think banks will feel more pressure to lower lending rates in line with the direction of the policy rate as BI has also signaled that it will continue to monitor policy transmission. However, bank liquidity remains a concern given the high loan-to-deposit ratio.
BI projects that stronger consumer spending and stable investment will strengthen domestic demand, which underpins national economic growth. For the year, economic growth is forecast at below the midpoint of the 5.0-5.4 percent range before increasing toward the middle of the 5.1-5.5 percent range in 2020 and inflation below the midpoint of the 3.5 percent plus or minus 1 percent and within the target range of 3 percent for 2020.
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