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ECONOMIC UPDATE - Monetary review - Saving ammunition



Maintaining stability

Bank Indonesia (BI) held its benchmark interest rate at 4.0% or unchanged from its previous level. The unchanged rate is in line with our and consensus expectations. We see keeping the rate unchanged is a move to safeguard the country’s macroeconomic stability amid recessionary risks. Thus, the deposit and lending facility rate stay at 3.25% and 4.75% as well. Lower inflation, bigger trade surplus and narrowing current account deficit (CAD) provide BI room to have a rate cut but we believe maintaining the rate unchanged is wise until the demand side is able to respond it better. 


More conducive indicators

Indonesia’s external sector gets more resilient after the ease of lockdowns in several major countries and the good news coming from vaccine occurs currently. In Aug-20, trade balance recorded a USD3.26 bn trade surplus or the highest surplus from 2011. Foreign capital flows in the form of portfolio investment recorded a net inflow totalling USD1.25 bn. The resilient economy built up foreign exchange (forex) reserve USD135.1 bn due to bond issuance. The forex reserves is sufficient as it is equivalent to finance 9 months of imports and 8.6 months of imports and servicing government's external debt. With CAD at 1.2% of GDP in 2Q20 and BI’s prediction of CAD around 1.5% of GDP, financial stability is supposed to be well. According to Mirza Adityaswara, former Deputy Governor of BI, on a private session, he mentioned that if CAD lands on more than 3% of GDP, it will trigger financial instability to Indonesia economy. Thus, the relatively low CAD may keep financial stability even under the current pandemic.


Risk of deflation

On other hand, deflation occurred in Jul-20 at 0.10% MoM although in yearly basis the inflation still came at 1.54% YoY. There is a possibility of deflation for next months as precautionary saving among middle upper-class income group remains under the uncertainty of pandemic. However, in UK, annual inflation rate jumped to 1% in Jul-20 from 0.6% in the previous month, beating market forecasts of 0.6% YoY. This may send signal that domestic demand is possible to grow under the pandemic time. Moreover, growing bonds issuance provides fresh liquidity and government’s stimulus related to National Economic Recovery (PEN) program may raise the inflation rate. As of last week, the realization of PEN has only achieved around Rp151.6 tn (USD10.3 bn) or 21.8% of total allocation of Rp695.2 tn (USD47 bn). We expect the realization will be accelerated from now to 4Q20 resulting higher money in circulation ahead. Thus, we still maintain our view that inflation will be at 3.1% in YE 2020 with probability of it goes lower.


Independency issue

On last our Monetary Review, we brought up the BI’s independency issue related to burden sharing scheme and BI’s stance as stand by buyer of government bond. We examine there is a correlation between central bank independency with inflation. Historically, after financial program for 1998 where BI was more independent, inflation showed a decreasing trend until now. Based on Joint Decree (SKB) of the Minister of Finance and the Governor of Bank Indonesia on April 16th and July 7th 2020, debt monetization is only being applied this year. Thus, BI will remain as standby buyer for Indonesian government bonds only until 2020. BI seems to keep its independence through giving limitation of intervention to some extent. Looking on how far BI has involved, until now, BI has bought Rp42.9 tn or 19.4% of total bonds issued by the government in Jul-Aug 2020 (after the enactment of SKB). We see the nominal is reasonable thus, we still believe in BI’s independency.


Saving monetary ammunition

As the monetary policy transmission usually takes around 6 months, we see BI still let the precious rate cut to take effect on 2H20 where business is more likely to increase their need of credit. Thus, keeping the rate unchanged is wise because whenever the condition gets worse, BI still has ammunition to use. However, we still maintain our initial view that BI will keep the rate at 4.0% until YE 2020 without ruling out the possibility of it getting lower in 2H20 as BI may use the rate cut to fuel up the growth in 4Q20.