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ECONOMIC UPDATE - Monetary Review - Fifty Shades of Rates



50 bps rate higher

After the surprising 50 bps rate from last month, Bank Indonesia (BI) continues its stance to increase the BI-7DRRR by 50 bps to 4.75% in Oct-22 or in line with consensus. BI chooses to do the rate hike by 50 bps in order to curb the soaring inflation and to manage the expectation of inflation ahead. This is also needed to tackle the detrimental effect of last month fuel prices hike on inflation. Indeed, the rate hike is also meant to stabilize the exchange rate. Because of it is expected, rupiah slightly rebounded against USD, driving the exchange rate from two-year highs of Rp15,587/USD to Rp15,567/USD at the spot market right away after the decision of rate hike has been taken.


Fed will be less hawkish in YE 22

There will be no FOMC Meeting in Oct-22. From last month monetary policy, the Fed increased 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 Chicago Fed President claims that the Fed is facing a difficult messaging problem as it nears a decision to halt the pace of rate hike. He also sees if the hawkish stance remains, it could tip the economy into a recession. This might send the signal of the Fed is getting less hawkish ahead. Thus, we expect the Fed will continue its 75 bps of rate hike in Nov-22 but it will be less hawkish by increase the rate by 50 bps in Dec-22. Eventually, FFR will achieve 4.25-4.5% in YE 22.


Shades of rates

When interest rates are high, it is more expensive to borrow money. By having higher interest rate, it might hamper the business activity. With today rate hike, BI brings the rate to its highest since Feb-20. This means, the cost of borrowing has gone back to the pre-pandemic level. Unfortunately, the strength of business activity has not gone back to that level yet. However, at the cost of inflation, we see the rate hike is needed to control the aggregate price that has been burdensome for the people especially the middle-low class. This is a hard decision to make as it contains different shades, different effects to several aspects. To make the least harm, we assess BI has to choose to tame the inflation first as it will be more painful to restore price stability if it is too late. 


Stable external resiliency

The foreign exchange (forex) reserve was at USD130.8 bn in Sep-22. The reserves remained sufficiently high as it was equivalent to finance 5.9 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 weeks. However, the 9.17% YtD depreciation of rupiah, on Oct, 20th 2022, is relatively better than the depreciation of currencies of other developing countries, such as India 10.4%, Malaysia 11.8%, and Thailand 12.6%. With the ongoing monetary policy tightening from BI and the hint of Fed to slightly cool down its hawkish stance, we expect the DXY will slightly slope than rupiah might achieve Rp14,895/USD.


Another 50 bps rate hike

With the soaring inflation, persistent FFR hike, higher yield spread, the combination of them will lead to the depreciation of rupiah. To maintain the global optimism towards Indonesia, we see BI should increase the rate by 50 bps in the rest of 4Q22. Last month, we mentioned that we did not rule out the possibility of another 50 bps will be taken in 4Q22. Thus, we increase our BI-7DRRR target from 4.75% to 5.25% for the YE 2022 to stabilize the exchange rate and to tame the inflation without risking the potential economic growth for next year.