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.