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ECONOMIC UPDATE - Monetary Review - Firing on all cylinders



Surprising 50 bps rate hike

Bank Indonesia (BI) continues its stance to curb the inflation by increasing the BI-7DRRR by 50 bps to 4.25% in Sep-22. This is higher than consensus at 4%. Despite of being a surprise, it is also favorable in order to tackle the detrimental effect of fuel prices hike on inflation. This is the part of gradual monetary tightening, after last month BI increased the rate for the first time since 2018. Compared to what the Fed just did, BI works on moderate hawkish pace since both economies face different challenge but same root; cost-push inflation. The higher interest rate is not only meant to combat inflation but also to guard Indonesia from the adverse impact on capital outflows due to other countries’ monetary tightening policy.


Fed stays hawkish

From the last night FOMC Meeting, the Fed is still committed to achieve 2% of inflation in 2022. Thus, the Fed also continues its hawkish stance by increasing the Fed Fund Rate (FFR) by 75 bps to 3-3.25% and signaling more large increases to come where it may achieve 4.4% in YE 2022 and topping to 4.6% in 2023. The daring rate hike is taken to combat the soaring inflation where it stood at 8.3% YoY (consensus 8.1% YoY) in Aug-22. We grasp the key point of current Fed’s stance from the Fed Chairman’s sentence: “higher interest rate, slower growth, and softening labor market are all painful… but it's not as painful as falling to restore price stability (later).” Thus, this serves as a hint that the hawkish stance remains until the inflation gets back to 2%.


What the Governor of BI says

BI emphasized that the 50 bps rate hike serves as the pre-emptive and forward looking measure to lower inflation expectations and ensured core inflation will be returning to the target of 3±1% in the 3Q23. BI also acknowledges the non-subsidized fuel prices hike brings additional inflationary pressure where the second-round impact of it can be witnessed for the next 3 months. The inflation in FY 2022 will be slightly higher than 6% since the fuel prices hike brings additional 1.8% to the headline inflation. This is why the front-loaded rate hike was taken instead of only 25 bps. Moving forward, BI conveyed that the more aggressive rate hike was not necessary due to the tamer inflation in 4Q22.


Stable external resiliency

The Indonesia’s official foreign exchange reserve was at USD132.2 bn in Aug-22. The reserves remained sufficiently high as it was equivalent to finance 6 months of imports and servicing government's external debt yet it was well above the international standard of reserve adequacy of 3 months of imports. It is true that rupiah depreciated to around Rp15,000/USD in the last few days. However, the 4.97% YtD depreciation of rupiah, on Sep, 21st2022, is relatively better than the depreciation of currencies of other developing countries, such as India 7.02%, Malaysia 8.51%, and Thailand 10.7%. Ahead, we still hold our rupiah estimate at Rp14,675/USD in YE 2022 as DXY is now significantly overvalued in real effective terms.


Catching up with FFR

With the persistent FFR hike, it may widen the yield spread, resulting in capital outflows and the depreciation of rupiah. Eventually, this indicates the rising pessimism of global investors toward Indonesia’s prospect. Although BI will not impose the hawkish stance as aggressive as the Fed, BI will be firing all the cylinders so the yield spread and real interest rate spread can be narrower. Since the rate hike is quite surprising, we do not rule out the possibility of another 50 bps will be taken by BI in 4Q22 to tame the inflation without risking the potential economic growth in the rest of 2022 and next year.