Indonesia's central bank mulls tightening monetary policy starting next year

Jakarta

BANK Indonesia could begin tightening monetary policy next year, including potential moves on interest rates, if the economic recovery remains on track and policymakers see signs of inflation, governor Perry Warjiyo said on Friday.

The bank's exit strategy is to gradually reduce liquidity in the financial system "and then later, the end of next year, maybe some interest rate action", Mr Warjiyo told Bloomberg Television. "But this is very uncertain."

Part of that uncertainty is the outlook for economic growth, as the government reimposes stringent movement restrictions over large parts of the country to contain its worst Covid-19 wave yet.

Mr Warjiyo on Monday slashed Bank Indonesia's growth outlook to 3.8 per cent this year, from 4.1-5.1 per cent, assuming the virus curbs stay for a month and lead to less mobility and consumption.

The government recently downgraded its own forecast for the economy to 3.7-4.5 per cent growth this year, from 4.5-5.3 per cent previously after it reinstated stringent movement curbs over large parts of the country.

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Rather than cutting rates further right now, Mr Warjiyo said the central bank would "maintain this low interest rate" and push banks to pass it on. Bank Indonesia has kept its key rate at a record low 3.50 per cent since February.

"What we're focusing on now, we're pushing the banks to follow suit," he said. "We're focusing more how to ensure the effectiveness or the transmission of our policy."

As rising poverty and unemployment amid the pandemic send Indonesia back to lower-middle income status, the government may need to risk a wider budget deficit to accommodate higher stimulus spending and delayed tax hikes.

The bank will be watching closely how the pandemic impacts domestic consumption, the cornerstone of South-east Asia's largest economy. For now, exports will continue driving economic growth thanks to the recovery in the US and China, Mr Warjiyo said.

The central bank is readying macro-prudential measures, which could include fiscal incentives, to support small and medium enterprises, as well as hotels and restaurants, he said.

An earlier move to ease down-payment requirements proved effective in prodding housing and car loans.

"With domestic Covid trajectory weighing on the growth outlook, it might be prudent for Bank Indonesia to start dropping hints to the market on eventual monetary policy normalisation plans. At the very least, it helps to ease a key driver of market uncertainty," said Yanxi Tan, foreign exchange strategist at Malayan Banking in Singapore.

Bank Indonesia's focus for the rest of the year is on keeping rates low and liquidity flush to support the economy, and maintaining a stable exchange rate, Mr Warjiyo said.

"We need to dance with the market, to ensure the stability of the exchange rate, the government bond yield, giving some room for adjustment but measurable, controllable and stable," he said. BLOOMBERG