Bank Indonesia dials up rate hikes

Decision: Bank Indonesia delivered a larger-than-expected 50bp hike on Thursday, taking the 7-day rate to 4.25%. Besides domestic considerations, this move underscores shifts in the global policy environment following the US Fed’s higher-for-longer hawkish rhetoric in overnight trade. Separately, in the day Philippines’ BSP also undertook a 50bp hike in line with consensus, as the economy faces the double whammy of high inflation (core and headline are above target) as well as sharp depreciation in the currency. This hike takes BSP’s cumulative moves since May to 225bps and the rate is higher than the pre-pandemic 4Q19 figure of 4.0%. The aggressive hike clearly underpins the central bank’s commitment to bring headline inflation back to its 2-4% target range.

Economic assessment: Governor Warjiyo cited inflation risks as a key need for policy to be front-loaded and pre-emptive, besides lending stability to the currency. The lag in policy transmission was pegged at about four quarters. BI maintained a cautious view on pipeline inflationary risks from the fuel price hikes, expecting the second-round effects to surface in three months. Headline inflation is expected to rise above 6% by late-year and return towards 4% by second half of 2023. Core CPI is expected to peak at 4.6% by end year.

The outlook on growth was upbeat, which in our view, provided sufficient buffer for the policymakers to dial up rate hikes. 3Q22 GDP growth was pegged at 5.5%, rising from 1H average of 5.2%. Full year growth is seen at the upper end of the indicative 4.5-5.3% this year. Loan growth has also registered double digit rise in the past 2-3 months, with a lower than pre-pandemic levels of loan deposit ratio reducing the likelihood that the banks will be swift in passing the policy shifts on the lending rates.

Policy outlook: Bank Indonesia’s rate path took a hawkish turn in light of two-pronged risks, a) domestic inflation expected to quicken on first and second order impact from the subsidised fuel price hike, b) pressure on the currency from a strong USD fuelled by a hawkish Fed, notwithstanding a strong trade account. Resilience in the growth trajectory also prodded policymakers to undertake frontloaded and aggressive policy action. With Thursday’s hike, the first 50bp of our 100bp forecast for Sep-Dec22 has been delivered (Indonesia’s fuel price hike, a medium-term positive). We add a 25bp hike to our path and expect the end-year rate to now rise to 5% (vs 4.75% expected earlier). Based on our current forecasts, BI’s policy rate will be 50bp higher than the US Fed Funds Rate by Dec22.

On bonds, the central bank indicated that operation twist operations are likely to continue to rein in longer-term rates, whilst allowing the short end rates to adjust according to the liquidity and policy adjustments.

Current account in good health

String of strong trade surpluses continued into 3Q22. August goods trade surplus jumped to $5.8bn, defying expectations of a narrower trade balance. This marks the second highest surplus on record and about 28 consecutive months of positive balance, lifted by high mineral fuels, iron & steel, edible oil sales, amongst others. Jan-Aug22 balance totalled $34.9bn, more than double from $18.7bn in the comparable period year ago. Strong balances have allowed for rupiah stability and underpinned the momentum in foreign inflows.

Exports jumped 30%yoy to $27.9bn to a record high on nominal terms, accompanied by 33% rise in imports at $22.1bn. The breakdown saw mining exports jump 63.2%yoy, oil & gas 65%, agriculture 31.2% and manufacturing 20.6%. Volume of palm oil exports was high at 3.6mn tons ($3.7bn) and coal at 32.8mn ($4.4bn). The destination wise breakdown saw non-oil shipments to China rise 22.6% mom-, EU 22.4%, US 3%, and Singapore 9%. As European economies seek alternative energy suppliers, purchases from Indonesia will be supportive of the external math. Concurrently, under imports, base effects weighed on consumer goods growth, 35% rise in raw materials (largest component) and 47% capital goods. We expect imports to be ramped up further in midst of the demand restoration as well as expectations of higher investment spends by the private as well as public sector.

A strong non-oil non-gas trade account helped prop the 2Q22 current account surplus to $3.9bn (1.1% of GDP) from $0.4bn in 1Q. With the Jan-Aug trade surplus having surpassed our full-year estimate, we expect the current account to register a larger surplus this year of 0.4% of GDP surplus from 0.2% forecasted earlier and second consecutive year of a positive balance. Dollar surfeit has provided relative stability to the currency, with BI’s hikes to add to that relative outperformance.

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