Scissors market

ECONOMIC UPDATE - Monetary review - Steady rate



Start the year with 3.75% of BI-7DRRR 

Bank Indonesia (BI) held its benchmark interest rate at 3.75% in Jan-21 or in line with our and consensus expectations. Thus, the deposit and lending facility were unchanged at 3.0% and 4.5% respectively. The rate cut is consistent with the higher projected inflation in 2021 and BI’s target of exchange rate stability. We see the unchanged rate is due to the more conducive recent economic condition. Besides, BI still uses the wait-and-see approach towards the Fed rate. According to the Fed's December Summary of Economic Projections, no FOMC participant expects a rate hike in 2021. For the end of 2022, only one out of the 17 expects a 25 bps rate hike. For the end of 2023, 5 expect at least one rate hike.


Conducive economic condition

The external factors showed stronger resiliency reflected by CAD that will get narrower to below 1.5% of GDP where trade surplus in Dec-20 was at USD2.1 bn. The foreign exchange (forex) reserves in Dec-20 was at USD135.9 bn or equivalent to 10.2 months of imports or 9.8 months of imports and servicing government external debt, which is well above the international adequacy standard of 3 months. We expect higher forex reserves amid the bond auction in this month. Rupiah also showed more conducive movement since the beginning of Nov-20 and closed the year at Rp14,050. We see the stable exchange rate will remain until at least 1H21 as dollar gets weaker.


Looser liquidity

In 2020, BI has injected Rp726.6 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 Rp555.8 tn. The loose liquidity conditions pushed up the ratio of liquid assets to deposits to 31.7%, coupled with a low overnight interbank rate of 3.04% in Dec-20. Furthermore, loose liquidity and BI-7DRRR contributed to lower deposit and lending rates from 4.74% and 9.32% in Nov-20 to 4.53% and 9.21% in Dec-20 respectively. Lower deposit and lending rates are expected to persist due to loose liquidity conditions and the low BI-7DRRR.


Optimism on inflation

This year, BI is optimistic that the actual inflation rate will be in the range of the inflation target at 3±1% in YE 2021. M1 and M2 growth recorded high to 18.5% YoY and 12.4% YoY respectively in Dec-20 or slightly lower than Nov-20. Still, the relatively high money supply has not translated into serious inflation. As the economy gets better ahead, we see the inflation will pick up to more than 2% in 1Q20 supported by the festive days; Chinese New Year and Ascension Day of Prophet Muhammad. However, the impact is limited due to the public activity restriction enforcement (PPKM), new measures from the government to restrict activities amid the pandemic.


Steady rate in short run

Thanks to the trillions of dollars in monetary and fiscal support from the Fed and the US government, dollar weakens and leads to the appreciation of rupiah as well. In addition, capital inflow from the developed economies in form of portfolio investment after the US election is expected to increase from USD11 bn in 2020 to USD19.1 bn this year. From some indicators above, wider room for rate cut remains exist in 1H21. Concerning on the similar real interest rate in Dec-20 (2.06%) with Jan-20 (2.32%) as the pre-pandemic level, we see 3.5% is the most reasonable rate in 2021 as the inflation will be higher eventually. In the nearer sight, we see if in Jan 26th-27th FOMC Meeting the Fed holds its rate unchanged at 0%-0.25%, then BI will hold BI-7DRRR unchanged in Feb-20.