Interest Rate in Indonesia

     The Bank of Indonesia (BI) decided to increase base interest rate by 25bp, from 7.50% to 7.75%, on November 18 to stabilize inflation rate, and strength the Government’s fuel subsidy reform. The BI aimed to lower the inflation expectation, and ensure that inflationary pressures remain under control. Indonesia’s inflation rate spiked up from 4.8% to 6.2% in a month after the Indonesian president Widodo started his term on October 20. Indonesia already experienced a steep uprising inflation rate when fuel price increased by 22% in mid-2013. Indonesia is again experiences spiking inflation rate even before the reform is implemented.

     This 25bp increased interest rate expects to stabilize consumer price, which strengths the President Widodo’s energy reform. If price is stabilized while fuel subsidy is reduced, the government is likely to save almost IDR120 trillion ($9.6 billion) to use for infrastructure and social welfare including education and medical industries. The government expects this policy to attract more foreign investments.

     Yet there is a concern about the BI’s monetary policy that goes opposite to current monetary policy trend to low the interest rate. The PBOC cut interest rate by 40bps, from 6.0% to 5.4%, and indicates additional interest rate cut in the future, the BOJ put additional stimulus around 80 trillion yen ($682 billion) by expanding quantitative easing, the ECB is expected to add as much as 1 trillion euros ($1.24 trillion).

     Some say that Indonesia’s economic structure is vulnerable to external economy that this increased interest rate will delay economic growth. After quantitative easing is over, rupiah can be dramatically depreciated that another financial crisis will be occurred. Rupiah has been depreciated around 23% from a year earlier, and its current account decreases as oil import increases to catch up the local demand. While GDP rose only 5.01% in Q3, Indonesia’s current account deficit is declined to 3.07%, similar level with financial crisis period.

Figure 1Indonesia Current Account to GDP. It is similar level with financial crisis period.
Source: Bank of Indonesia, tradingeconomics.com

     But there is a bright side of Indonesia economy. Unlike financial crisis period, Indonesia’s foreign exchange reserves grows almost 8 times larger; it is large enough to protect exchange rate. Import in oil, which was the majority reason for decline in current account, is decreasing as its consumption declines as a result of energy reform. Indonesia’s financial market is still vulnerable to external sources, but Indonesia has a large domestic market to stabilize economic growth when other countries implement Exit Plan.

Figure 2Indonesia Foreign Exchange Reserve. It is continuously increasing.
Source: Bank of Indonesia, tradingeconomics.com

     The BI’s decision to rise interest rate aims at both stabilizing inflation rate and economic growth at the same time. Even though its economic growth slows down last two quarters, this new interest rate will help the president Widodo’s policy to increase government spending and foreign investment, and recover its growth rate.

December Week 1

   The S&P 500 rose 2.56% this week as several economic indicators brightened economic forecast. ISM Manufacturing PMI decreased from 59.0 to 58.7, above expectation of 57.9 while ISM New Order slightly increased from 65.8 to 66.0. With low oil price, manufacturing managers are more confidence with economic forecast that is likely to boost U.S. economy along with strength labor market.

   Federal Reserve Vice Chairman Stanley Fisher signaled to increase interest rate in a mean time as labor market improves more than expected. Unlike past couple of months, this news had a positive view on the market. Vice Chairman Fisher said that the Fed. will not surprise the market when it increases the interest rate, which means that there will be a plenty of signal when it does.

   Unemployment rate stays the same from last month at 5.8%. What surprised the market were nonfarm payroll and average hourly earnings. The nonfarm payroll increased from 243k to 321k, and average hourly earning also rose from 0.2% to 0.4%. It seems like Black Friday helped manufacturing industry that increased payroll. This level is expected to stay until next month as another holiday season is coming, Christmas.

Europe generally had a good week as crude oil price increased. Manufacturing and service PMIs declined but it didn't largely effect on the market. Low oil price already dragging European economy down that low PMIs were expected.

   All major European markets increased; DAX for 1.57%, CAC 40 for 1.37%, and FTSE 100 for 1.10%. As oil price increased, market participants expect to stabilize inflation rate; fading deflation fear away. The ECB president Mario Draghi still is indeterminate whether the ECB will implement the quantitative easing. It decreased market to -1.0% on Thursday. But on Friday, EU GDP was announced to 0.8% YoY; stagnated for three consecutive months. Improved U.S. labor market also signaled positive view on European.

   As a result, the DAX rose by 2.39%; cover -1.0% loss on Thursday. Unlike other European markets, FTSE 100 wasn't largely effected by the president Draghi's speech. Of course, not only it is not part of EU, the BOE's monetary policy is working fine. U.K. Service PMI surged to 58.6 from 56.2, and housing price is also stabilizing. The BOE is unlikely to rise interst rate soon; the FTSE is likely to continuously improve.

 


 


USD continuously strengthens this week. While crude oil increased by 1.45%, JPY and EUR depreciated 2.24% and 1.38% against USD respectively. JPY increased up to 120 yen/dollar this week. This strong dollar is expected to continue as oil price keeps low level, and quantitative easing still implemented, or expected to implement in those markets.