Lower BI rate: Gear up on the bumpy road

BI cuts benchmark rate by 25bp as expected

Amid dread over Jakarta’s bombing terror, the central bank cut its benchmark rate by 25bps to 7.25% at the BOG meeting on 14 January, in line with our expectation as well as couple of economists’ expectations surveyed by Bloomberg. Bank Indonesia also lowered its deposit facility rate by 25bps to 5.25% and its lending facility rate to 7.75%. This move has somewhat ended BI rate cut saga, providing better certainty to the financial market regarding the central bank’s policy priority.

Four key factors behind the lower rate cut

In our view, we believe BI’s decision to bring down its policy rates due to four major factors including 1) Weak GDP growth, 2) Manageable current account deficit, 3) Low inflationary pressure, and 4) Relatively stable Rupiah. On the GDP, the central bank annunciated 4Q15 economic growth to remain modest, with engine driver only come from government spending. Since energy and commodity prices were at bay, exports and private investment should remain under pressures. We concur with BI’s view as we expect 4Q15 GDP would only grow 4.85%, resulting in full-year level at 4.74% (2014: 5.03%). On the flip side, BI expects 2015 current account deficit to remain under control, easing to 2% of GDP, lower than the central bank’s initial projection on the backdrop of sharper contraction in imports. Additionally, BI also believes inflationary pressure should remain benign on lower fuel prices and a mild El Nino effect on the volatile food component which just rose 4.84% YoY last year. BI targets 2016-2017 inflation would range at 3%-5% YoY. On the last factor, the central bank underlined that current Rupiah stabilization was the main consideration behind lower benchmark rates amid further CNY soft devaluation and slump in commodity prices.    

Bolder easing-bias to support fiscal expansion; Expect more cut rates to come 

Prior to the current statement, in the past three consecutive release statements, the central bank hinted that a room for rate hike once external volatilities to dissipate. Thus, we believe the current rate cut may allow for other series of benchmark rate reduction in the near term. On the latest opening release statement, BI has indicated that it could conduct a further monetary easing after deliberation of domestic and external economic assessments. Thus, a complete loosening monetary policy will support fiscal expansive measure by the government, helping 2016 GDP growth to accelerate to above 5% level. At this stage, our BI rate target of 6.75% remains intact this year. We hope BI may continue to gradually cut its benchmark rate in February and March along with seasonality deflation. However, our timing expectation should be subjected to assumptions related to external factors including not too aggressive The Fed’s monetary policy normalization and a milder pace of China’s economic downturn. Given these presumptions, we foresee global market volatilities should further ease, supporting BI to conduct another episode of rate cuts.