ECONOMIC UPDATE - Monetary review - Lame rate cut

 

 

Unmatched Covid-19

Talking about basic monetary policy, it emphasizes more on demand side as it may affect the liquidity in society. However, Covid-19 does not only bring impact on demand side, but supply side as well. Related to previous global major crisis, they all were caused by demand shock (due to natural disasters, terrorist attack, etc.) and supply shock (due to commodity price hike, severe inflation, etc.). If we are allowed to break down another crisis cause like financial shock (take a look on 2008 Global Financial Crisis), it counts.  Unfortunately, Covid-19 brings those three shocks at once. Due to the outbreak, Bank Indonesia (BI) decided to cut its BI 7-Day Reverse Repo Rate (BI-7DRRR) by 25 bps from 4.75% to 4.50% or aligned with our and consensus expectations. BI also cut the deposit and lending facility rate as well by 25 bps to3.75% and 5.25%, respectively. However, the rate cut is only effective in facing the demand shock (and financial shock). To be noted, through another monetary policies taken by BI, we can expect rosy outcome rather than just hoping for another deeper rate cut. The lower rate is taken alongside with BI’s revised down estimation on economic growth in 2020 from 5.0-5.4% YoY to 4.2-4.6% YoY. BI believes that the economic growth will go up eventually. Thus, in 2021, BI predicts the growth will be at 5.2%-5.6% YoY.

 

Staggering rupiah 

Rupiah continues to depreciate by 14.5% YtD and until now it has reached Rp15,880/USD. The last time it touched that level was in Jun-98 due to the Asian Financial Crisis. The foreign exchange (forex) reserves will face a downtrend where it has decreased by 0.99% MoM to USD130.4 bn in Feb-20. It remained sufficient as it was equivalent to finance 7.7 months of imports and 7.4 months of imports and servicing government's external debt yet it was well above the international standard of reserve adequacy of 3 months of imports. Interestingly, amid the potential supply shock in 1H20, BI still holds the inflation target at 3.0±1% in YE 2020. We see this target is held due to the administered price in 2020 will be maintained low by the government where the government has cancelled some price increase plans so far.

 

More active and accommodative

BI realizes that they can have deeper rate cut just like what the Fed has done, but BI conveyed that it is no necessary. They keep on emphasizing that rate cut is not the only instrument amid this hardship since BI has another substantial instruments like triple intervention and open market operation (OMO) where BI has bought Rp195 tn of government securities to stabilize the market until Mar-20. The OMO aims to limit the possible hike on Indonesia’s bond yields in near future. In addition, BI will hold meeting twice a week starts from next March, 24^th2020 to give update on policy responses toward the economy in order to bring back investors’ confidence

 

Expecting lower rate

The wait-and-see approach loses its relevance since the Fed rate has run zero interest rate policy (ZIRP). We see it will be less likely to be followed by BI since monetary policy is insufficient to tackle the supply shock. Amid the fast-paced depreciation of rupiah, rate cut is not actually preferable. In short run, we see the rate cut will not help much as the shocks come from the supply side. Yet, tourism as the most impacted by Covid-19 is not directly related to monetary transmission. However, to limit the yield hike, we see rate cut will be taken twice more to 4.0% in YE 2020. Thus, we revise down our view that BI will have another rate cut by 50 bps in 2Q20 with another monetary intervention. For another macroeconomic indicators, the estimations are still under our review due to this fast-paced economic condition.