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ECONOMIC UPDATE - Monetary review- Favorable rate cut



Rate cut after 4 months unchanged

Bank Indonesia (BI) cut its benchmark interest rate by 25 bps to 3.75% in Nov-20. In contrast, our expectation and consensus saw that BI would hold the rate unchanged previously. Thus, the deposit and lending facility were slashed to 3.00% and 4.50% respectively. The rate cut is meant to be as a follow-up action to drive the national economic recovery during the pandemic. The rate cut is consistent with the low projected inflation, bigger trade surplus and maintained external stability. So far in 2020, BI has cut the rate by 125 bps to keep up with the downside effect of the pandemic. Lowering the rate may take about six months to fully integrate into the economy. Looking back, this is the first rate cut after its last rate cut since Jul-20. Ergo, the rate cut is favorable as we prefer small consistent steps for the positive effect of rate cut to kick in.


US Election provides better resiliency

Biden’s victory in US Election brings positive sentiment for international trade and market. The better global outlook will trickle into Indonesia financial market by enhancing the risk appetite. It has successfully boosted the stock market index where JCI has increased by 6.35% after the claim of Biden’s winning. As the Democrats favor the more contractive fiscal policy, it will benefit Indonesia’s market as investors seek the friendlier fiscal regime for the medium run ahead. As a result, Indonesia shows better resiliency although the reimplementation of large-scale social restrictions (PSBB) in Sept 14th. The external factors showed stronger resiliency reflected by CAD that will get narrower to below 1.5% of GDP where trade surplus in Oct-20 was at USD3.6 bn or higher than expected. The foreign exchange (forex) reserves in Oct-20 was at USD133.7 bn or equivalent to 9.7 months of imports or 9.3 months of imports and servicing government external debt, which is well above the international adequacy standard of 3 months. On the other hand, rupiah showed significant progress where it appreciated by 3.64% MoM on Nov 19th 2020.


Focus on liquidity

Although BI did the rate cut, BI still focuses on liquidity where as of Nov 17th 2020, BI has injected Rp680.9 tn of additional liquidity into the banking system through quantitative easing, primarily in the form of lower reserve requirements totaling Rp155 tn and monetary expansion totaling Rp510.1 tn. The loose liquidity conditions pushed up the ratio of liquid assets to deposits to 30.7%, coupled with a low overnight interbank rate of 3.29% in Oct-20. Furthermore, loose liquidity and BI-7DRRR contributed to lower deposit and lending rates from 5.18% and 9.42% in Sep-20 to 4.93% and 9.38% in Oct-20 respectively. Besides, M1 and M2 growth recorded high to 18.5% YoY and 12.5% YoY respectively in Oct-20, primarily driven by expansive fiscal operations. However, the relatively high money supply has not translated into higher inflation. We see the impact of higher liquidity to inflation will be limited in short run at least until household consumption recovers faster than current condition.


Good rate cut

Globally, expectations of rate cuts in some major countries have melted within the space of a month on hopes a successful Covid-19 vaccine that will boost the economic growth. Unlike those major countries, BI has decided to have a rate cut. We see this is the way BI harnessing the wide room for rate cut provided by the better resiliency and rosy prospect. We do encourage BI to have rate cut from previous months as the real interest rate since Jul-20 (2.46%) was higher than the real interest rate in even Jan-20 (2.32%) where Covid-19 has not kicked in. Although the current real interest rate is a forecast at 2.31%, this is still a good rate cut. We recommend BI to be more focus on real interest rate instead of the nominal interest rate. Thus, we revise our estimation that this is the last rate cut in 2020 where BI will leave the rate at 3.75% in YE 2020 as inflation is expected to occur in Dec-20 and ahead.