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Analysis: Indonesia on track to lift rates by 3Q10

The Indonesian central bank, Bank Indonesia (BI), left rates unaltered at 6

Harry Su (The Jakarta Post)
Thu, April 8, 2010

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Analysis: Indonesia on track to lift rates by 3Q10

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he Indonesian central bank, Bank Indonesia (BI), left rates unaltered at 6.5 percent when the board of governors met on 6 April. This is in line with our expectation given March’s slight deflation and bank credit growth still weaker than the authorities would like to see.  

The policy statement did not provide much guidance in terms of when the central bank expects rates will change.

BI is currently relaxed about gains in consumer prices and expects inflation, which slowed to 3.4 percent year-on-year in March, will stay under its 6 percent target ceiling in 2010. We are not too certain.   

We are of the view that BI needs to be forward looking, particularly as the domestic economic upswing will remain strong while commodity prices move higher and electricity tariff increases are set to be implemented in July (i.e. 10 percent for low-end users and 15 percent for middle-up consumers).  We expect 2010 annual inflation to reach 6.1 percent, just slightly ahead of BI’s 6 percent target ceiling.

Although our economist expects just a 50-basis point hike in the benchmark interest rate, it is possible that the central bank would need to implement a 100-basis point hike to 7.50 percent to curb inflation depending on the severity of the hike in commodity prices.  Note that the Bloomberg consensus range has the median view at 7.00 percent by the end of this year.

In fact, it is possible that Indonesia could experience a decoupling between BI’s benchmark rate and banks’ rates in the real sector as is happening in Canada at the moment.  In Canada, the three biggest banks have raised their mortgage rates by 20-60 basis points on the back of the current economic recovery.  

Interestingly, various Indonesian bank directors have now started to talk about escalations in interest rates, although BI has kept its benchmark rate unchanged for now.  Going forward, we could see a first policy rate hike sometime in the third quarter, 2010, which means that government bond yields along all the curves will climb later this year. The bond sell-off could curb foreign inflows for awhile, especially since overseas exposure to Indonesian debt is now at record levels (please see chart for details).

Although we agree with BI that the rupiah could remain strong in the short-term, it is worth highlighting that capacity use in the industrial sector has moved up while administered prices for fuel and electricity will likely increase in the second half, 2010, given that the current oil price is already at an 18-month high above US$86 a barrel.

We expect the year-on-year consumer price gain will accelerate to the top end of the 4-6 percent target range later this year.  This will necessitate that BI start hiking rates starting in the third quarter 2010 at the latest to stay ahead of the curve and ensure that inflation does not become a major problem.

The authorities admittedly are still concerned about bank credit growth, but we note that average lending rates have dropped to 15.2 percent in early April from 16.0 percent a month earlier. 

Additionally, it is not unusual for credit growth to lag behind general economic improvement.  We expect that our target of 15 percent year-on-year loan growth this year from 11 percent in first quarter, 2010 could be achieved, although this is lower than the government’s expectation of 20 percent year-on-year growth.

With the Bank Century scandal still lingering, we expect some slowdown to occur on the government’s ability to implement new reforms.  This coupled with possible tardiness in the approval of the 2010 budget, which could slow down infrastructure-related projects, means that we expect only moderate growth in 2010 GDP growth of 5.2 percent, up from 4.5 percent in 2009.  

However, over the medium term, we still anticipate that Indonesia will achieve investment grade status in the next 12 months, and this means that foreign appetite for investing in the country’s bond and equity markets will likely increase further in the future.

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