The policy background: The most awaited monetary policy synchronization
It is worth noting that since the introduction of BI rate as the benchmark policy rate in 2005, the rate has faced some challenge in providing a reliable guidance in the domestic financial market. Post 2008 global crisis which emerging markets had been poured with massive capital inflows from The Fed’s quantitative easing, Jakarta Interbank Overnight Rate (JIBOR) movement plunged to its lowest level while at the same time, BI rate could not move in the concordant direction since inflation surged due to soaring fuel prices. Hence, this opposite trend had somewhat failed to generate a synchronized monetary guidance to the investors, triggering more inefficient and volatile financial market. Therefore, to create a better expectation anchor, a more reliable beacon is needed.
New benchmark rate to sharpen monetary policy transmission
Recently, stakeholders in the domestic financial market are still using different benchmark. First, in order to manage short-term liquidities, banks will see Deposit Facility (DF) rate (200 bps below BI rate) as a guideline for JIBOR. Second, banks or other financial institutions will standardize their targets of cost of funding as well as lending rate to be based on BI rate. To avoid a further inefficient term structure and misperception guidance, starting on 19 August, the central bank will replace BI rate with 7-day reverse repo rate (RR rate) which can also be utilized as monetary instrument. Differ to BI rate which is non-transactional, the new benchmark rate is tradable in the money market with current level at 5.5%. The monetary authority will also accompany the RR rate with more symmetric and narrower range of DF and Lending Facility (LF) rate. DF and LF will be pegged at 75 bps below for DF and above for LF from the RR rate. Our discussion with Bank Indonesia’s officials reveals that under the new policy rate, market players will see a single benchmark, thus, it may prompt a more efficient monetary policy transmission.
How reverse repo rate works?
Basically, as we can see on the chart besides, repo transaction occurs when banks to trade its securities’ ownerships with the central bank under repurchase agreement in purpose to obtain cash, while reverse repo is a transaction when the central bank conducts a repo of its securities ownership in order to absorb liquidities from banks. Given a current easing-bias environment, BI should maintain the RR rate to remain low, providing a not attractive yield which, in turn, could allow banks to gradually reduce its deposit and lending rates ahead.
Adjustment on macro assumptions should occur particularly for 2017
A more reliable and representative benchmark rate should bring an additional catalyst to the capital market, whereas an expected low level of RR rate (125 bps below BI rate using current reverse repo) may further bring down deposit and lending rates sooner-than-expected, accelerating domestic demand amid remains benign inflationary pressure. As we believe the full impact of this move will be seen next year, we will revisit our 2017 macro targets particularly for GDP growth, Rupiah and current account deficit.
The indirect impact for banks
The change from BI rate as benchmark to RR rate has certain potential direct and indirect consequences for banks. The indirect consequence relates to how effective BI monetary policy is after the change of benchmark to RR rate compares to BI rate as the benchmark. Should RR rate adoption as benchmark renders smoother transmission of monetary policy, this is beneficial for banks as BI can expand can lower market interest rate faster, thus enabling banks to trim cost of funds. In our view, the impact from the new policy for Indonesian banks is positive. Responding to government’s request of single digit lending rate at the end of 2016, banks have started to cut lending rates and any policy that can help market interest to be lower rate (such as the change of benchmark to RR rate) can help banks avoid drastic margin reduction.
