Economic Analysis - Monetary Tightening On The Horizon, Not If But When - MAY 2017

BMI View: We maintain our expectations for BI to stand pat over the near-term to support the domestic economy, but note that it will likely hike interest rates by 25bps to 5.00% before end-year to curtail the risk of capital flight and to keep inflation in check.

Consistent with our expectations, Bank Indonesia (BI) left its benchmark seven-day reverse repo rate (7-day RR Rate) unchanged at 4.75% during its monthly monetary policy meeting on March 16. The corresponding Deposit and Lending Facility rates were also kept constant at 4.00% and 5.50%, respectively. The decision was made by the BI Board of Governors citing "efforts to maintain macroeconomic and financial system stability amidst growing global uncertainty", after the US Fed hiked rates by 25bps on March 15. While we continue to expect BI to maintain an accommodative monetary policy in the near-term to support the economy, we note that there will likely be no further easing on the horizon. Instead, we believe that BI is likely to stay neutral for now, and will look to tighten its policy rates by 25bps to 5.00% over the coming months as capital flows reverse.

Our conviction for BI to adopt a neutral-to-hawkish monetary policy stance over the coming months has strengthened considerably over the past few weeks for three reasons. Firstly, after six interest rate cuts in 2016, BI's senior deputy governor Mirza Adityaswara signaled in a recent March 2017 interview that there will likely be no further easing as the benchmark rate is "low enough".

High Foreign Ownership Of Bonds Could Result In More Volatility
Indonesia - 10-Year Government Bond Yield, %
Source: BMI, Bloomberg

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