Not a birthday but surprise!
For the first time since Nov-18, finally Bank Indonesia (BI) has just raised the BI-7DRRR by 25 bps to 3.75% in Aug-22. This is quite surprising as this came in above the consensus estimate at 3.5% (unchanged). In Nov-18, the rate hike was 25 bps as well from 5.75% to 6.0% due to the further widening of the current account deficit (CAD) in 3Q18 because of the surging imports. The rate hike was taken after a long pause where BI slashed the rate by 25 bps to 3.5% in Feb-21 to spur the economic growth amid the pandemic. We assess the newest rate hike was taken to anticipate the detrimental effect of subsidized fuel price hike to the inflation in the near future. Now, the monetary policy cycle around the world is getting more synchronized with BI taking the rate hike as well.
What the governor says
The Board of Governor emphasized that the rate hike is a pre-emptive and forward-looking step to mitigate the risk of rising core inflation and inflation expectations due to the increase in non-subsidized fuel prices and volatile food inflation. Related to the plan of subsidized fuel price hike (Pertalite and Solar), BI stressed that it will only react to the second-round effect of the discourse. Repeatedly, BI also ensured that it would only raise the rate when a persistent rise in the core inflation occurs. The core inflation rate is also still within target at 2.86% YoY in Jul-22 but BI estimates it may go to 4.15% YoY in YE 2022.
Stable external resiliency
The surplus on current account balance in 2Q22 at USD3.85 bn (1.14% of GDP) reinforced the external resiliency for the rest of 2022 as 2H22 will be more challenging under assumption of the commodity prices moderation. The foreign exchange (forex) reserve in Jun-22 was also still sufficient at USD136.4 bn or equivalent to 6.4 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 this month. In spite of the 4.27% YtD depreciation of rupiah on Aug, 22nd 2022, it is relatively better than the depreciation of currencies of other developing countries, such as India 6.92%, Malaysia 7.13%, and Thailand 7.38%. Ahead, we are still optimistic for rupiah to appreciate to Rp14,675/USD in YE 2022 as DXY is now significantly overvalued in real effective terms.
Juggling with liquidity
Last month, BI held Rp1,263 tn (USD84.3bn) of bonds (vs Rp273.2 tn at YE 2019), after launching quantitative easing to help support the pandemic-hit economy. In order to soak the liquidity back, BI had sold around USD1.1 tn (USD73.4 mn) of bonds in Jul-22 and aimed to sell about Rp70 tn of bonds with maturities of five years and below. Anyway, BI and Ministry of Finance still hold the burden sharing agreement. Despite of the monetary policy tightening, the ratio of Liquid Assets to Third Party Funds (AL/DPK) was still sufficient at 27.92%, keeping the ability of banks to disburse loans. The liquidity also remained loose as reflected in the growth of M1 (14.9% YoY) and M2 (9.58% YoY) money supply.
Entering the era of soaring inflation, the rate hike is wise to be done in Aug-22 especially before the higher price of nonsubsidized fuel comes. It is true that we still see the difficulty in taming inflation-led by the global supply side disruption with monetary policy. BI also mentioned that the rate hike is not the first choice in its policy sequence. However, stable price is a crucial prerequisite for sustained economic growth as soaring inflation may hurt household purchasing power, the largest contributor of GDP growth. Delightfully, the 2Q22 economic growth of 5.44% YoY indicates the urgency for crisis level policy accommodation has passed. With the solid growth in 1H22, we expect BI will increase the rate by 50 bps more in 4Q22 to 4.25% to juggle with the inflation and the economic growth as well since no country is immune to the stagflation although we see the probability is low in 2022.