Indonesia raises interest rates as part of proactive monetary policy push

Indonesia’s central bank has moved to stabilise the value of the rupiah and contain capital outflows following the implementation of two interest rate rises in a month, part of a new proactive policy stance.

Following an out-of-cycle meeting called by newly appointed governor Perry Warjiyo, Bank Indonesia (BI) announced on May 30 that it had increased its key benchmark by 25 basis points to 4.75%, while flagging the possibility of further increases later this year.

The increase in the benchmark rate was the second rate rise in just 13 days, following the 25-basis-point jump announced on May 17, which itself was the first time the key rate had been raised in four years. The central bank also lifted its deposit facility and lending facility rates to 3.73% and 5.25%, respectively, in both cases an increase of 25 basis points.

To ease the impact of the rate increases, Warjiyo said the BI would also look at loosening its macroprudential rules, to be discussed during its meeting in late June.

Intervention to support stabilisation of the rupiah

The latest developments are in line with the bank’s intent to prioritise monetary policy to support the rupiah and curb capital outflows from the market.

“We will pre-empt and will be ahead of the curve in interest rate policy prescription, and then we will launch double intervention to stabilise the exchange rate and buy state securities from the market,” Warjiyo said on May 24 after being sworn in.  

The value of the currency fell 4.8% against the dollar between the beginning of the year and before the second interest rate increase was announced, under pressure from a number of factors, including rising oil prices, an expanding trade deficit, and expectations of increases in US rates and a tightening of monetary policy.

The BI also stepped up its foreign-exchange swap auction activity in May, seeking to ensure rupiah liquidity was maintained in the market, another move to keep the cost of the currency down.

The bank has some leeway in monetary policy, with the economy expanding by 5.1% year-on-year (y-o-y) in the first quarter and inflation running at 3.31% as of the end of April, well within BI’s range of 2.5-4.5%. However, possible further falls in the rupiah could raise import costs and the trade deficit, while expected rises in US rates could fuel additional capital outflows from emerging markets.

Banking sector stable amid external pressures

While the shifts in monetary policy could have an impact on lending rates moving forward, the developments come at a time when the banking sector is well positioned to cope with fluctuations. The capital adequacy ratio (CAR) stood at 22.5% at the end of March, with the minimum requirement under Basel III being 10.5%.

Credit growth has also continued to expand in recent months, increasing by 8.9% y-o-y in April, according to market regulator the Financial Services Authority (OJK).

Although the April figure follows growth of 8.5% in March, 8.2% in February and 7.4% in January, the rates are still below BI’s projected credit growth target of 10-12% this year.

One area of concern, however, is the non-performing loan (NPL) ratio of Indonesia’s banking system. NPLs rose to 2.79% of total credit portfolios in April, the OJK report said, up from the 2.75% in March, though still below February’s 2.9%.

Although on the rise, the OJK said that both credit and market risks were manageable, and the financial services sector was strong enough to mitigate the impact of global financial market dynamics.