ECONOMIC UPDATE - Monetary review - Third rate cut, one to go

 

 

Rate cut effect to take place in 2H20 

Bank Indonesia (BI) today delivered its third  cut on   benchmark interest rate by 25bps to 4.25% , which is the  lowest in two years and   aligned with consensus expectations. The cut is aimed to boost the economic growth as the economy starts to reopen in Jun-20 and forth. BI also cut the deposit and lending facility rate as well by 25 bps to 3.50% and 5.00%, respectively. Different with our estimate, we saw BI would maintain the rate unchanged at 4.50%. Previously, we saw the rate cut was unecessary to be taken in Jun-20 since demand of credit was weak and fiscal policy was more effective than monetary policy under the shock in demand and supply side. As the monetary policy transmission usually takes around 6 months, we see the current rate cut is prepared to take effect on 2H20 where business is more likely to increase their need of credit. Through another monetary policy taken by BI, we can expect rosy outcome. The lower rate is taken alongside with BI’s revised down estimation on economic growth in 2020 to 0.9-1.9% YoY. BI believes that the economic growth will go up eventually. Thus, in 2021, BI predicts the recovery phase is near and the growth in 2021 will be around 5-6%.

 

More conducive environment

As the global risk is gradually improving shown by the volatility index (VIX) that shrinked by 40.6% from its highest level on Mar-20 at 82.7 to current level at 33.6, we face a more conducive economy. The global investors’ optimism increased as the Federal Reserve announced that the Fed will buy bonds from the secondary market. Increasing global investors’ optimism may also become a positive sentiment which will open a room for Indonesia’s market strengthening in the near term. Looking at the last auction where Indonesian government absorbed Rp20.5 tn from a total incoming bids of Rp94.8 tn, it added positive sentiment to the domestic bond market. Besides, rupiah displays better performance where it records at Rp14,118/USD currently ,  appreciating  by 14.8% from its weakest level at Rp16,575/USD in Mar-20. Meanwhile, the foreign exchange (forex) reserves increased by 2.03% MoM to USD130.5 bn in May-20. It remained sufficient as it was equivalent to finance 8.3 months of imports and 8 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. The increase of forex reserves came from USD5.4 bn of net inflows, mainly in sovereign debt papers from April to May. In addition, enormous trade surplus in May-20 at USD2.1 bn as the result of decline in import (-42.2% YoY) outpacing the plummet in export (-28.9% YoY), this brought wider room for BI to have this cut.

 

Expecting lower rate

Amid the potential supply shock, BI still holds the inflation target at 3.0±1% in YE 2020. BPS recorded inflation 2.19% YoY in May-20 or the lowest in 20 years but still manageable. To avoid the potential inflation hike in 2H20 due to the growing money supply from quantitative easing, we see maintaining the moderate BI-7DRRR is important. Thus, we expect there will be no aggressive rate cut following the current rate cut. Fundamentally, BI realizes that they can have deeper rate cut by conveying that it is no necessary. In short run, we see the rate cut will not help much as the real sector are not selling enough to use the capacity they already have. Yet, we view tourism as one of the hardest hits by the COVID-19 is not directly related to monetary transmission. However, to boost the economic growth from another sector and further utilization, we still maintain our initial view that the rate cut will be taken once more to 4.0% in YE 2020.