Indonesia’s central bank surprises with ‘pre-emptive’ rate hike to cushion falling rupiah

INDONESIA’S central bank defied majority expectations with a hawkish stance, raising its key interest rate on Wednesday (Apr 24) to support the battered rupiah, which has reached four-year lows on the back of a rallying US dollar.

The central bank hiked the benchmark seven-day reverse repurchase rate by 25 basis points to 6.25 per cent – its first hike this year and its eighth since the bank began a tightening cycle in 2022.

The overnight deposit facility and lending facility rates were similarly raised by 25 basis points to 5.5 per cent and 7 per cent, respectively.

The rate hike comes as a response to the recent pressure on the Indonesian rupiah, which hit 16,200 against the US dollar, the lowest level since 2020. The rupiah has weakened by 5.07 per cent since the start of the year.

This pressure has been exacerbated by the surge in US Treasury yields and escalating geopolitical tensions in the Middle East, prompting investors to favor safe-haven assets.

Irman Faiz, an economist at Danamon Bank, said a hike is inevitable for Bank Indonesia (BI), noting the current external pressures could hinder the rupiah’s strengthening unless it increases the benchmark interest rate.

“Indonesia’s foreign exchange reserves have significantly declined due to intervention. The effort to stabilise the Rupiah amidst future uncertain global conditions becomes challenging without a rate hike,” Faiz told The Business Times.

BI governor Perry Warjiyo said the hike aims to bolster the stability of the rupiah exchange rate amid escalating global risks. “It also serves as a preemptive and forward-looking step to ensure that inflation remains within the target range, in line with the pro-stability monetary policy stance,” he added.

Inflation in South-east Asia’s largest economy surged to 3.05 per cent in March, marking its highest level in seven months. The surge was driven by escalating food prices in anticipation of heightened demand during Ramadan and the Eid al-Fitr holiday.

The central bank set an inflation target around 1.5 to 3.5 per cent in 2024 and 2025.

Warjiyo emphasised that the central bank remains committed to enhancing its policy aimed at stabilising the currency exchange rate.

This involves active intervention, particularly through the spot and domestic non-deliverable forwards markets, while simultaneously increasing the appeal of rupiah-denominated assets.

Even with the rate decision, BI kept its growth forecast for economic growth at 4.7 to 5.5 per cent in 2024. The loan growth is expected to grow to 10 to 12 per cent this year despite the hike in the borrowing rate.

Warjiyo stated that BI will facilitate domestic lending growth by relaxing liquidity requirements for banks, emphasising BI’s pro-growth macroprudential policy stance.

While uncertainty in the global market still lingers, the central bank forecast that the rupiah will stabilise at around 16,200 against the US dollar in Q2. It will gradually strengthen to about 16,000 rupiah per US dollar in Q3. The aim is for the currency to reach 15,800 rupiah per US dollar by the end of this year.

BI’s latest move was deemed a surprise as a majority of pundits had expected the central bank to leave its benchmark interest rate unchanged, following a surprise hike last October.

Of Bloomberg’s poll of 41 economists and analysts, merely 12 had anticipated a 25 basis points increase in the benchmark interest rate; the rest expected the policymaker to hold it.

Radhika Rao, senior economist at DBS, stated that a modest hike is not a panacea for rupiah weakness, emphasising that BI should make further efforts in triple intervention in the market to instil confidence and establish a higher real rate advantage in favour of the currency.

Analysts have said the rupiah’s weakness is holding BI back from cutting interest rates this year.

However, there are concerns that further tightening may hurt growth in the consumption-led economy and worsen the decline in purchasing power. All this could unfold in the final year of President Joko Widodo’s tenure, said Teuku Riefky, economist from the Economic Faculty of University Indonesia.

Indonesia’s economy grew 5.05 per cent in 2023 amid falling exports, slowing consumption.

“We can anticipate a slowdown in growth for this year due to declining purchasing power resulting from soaring food prices and the implementation of tightening monetary policies since August 2022, which have led to reduced household consumption,” he said.