The central bank of Indonesia, Bank Indonesia, left its interest rate regime unchanged - for the fourth straight month - at the January 2018 policy meeting. The benchmark BI 7-day Reverse Repo Rate was kept at 4.25 percent, while the deposit facility and lending facility rates were held at 3.50 percent and 5.00 percent, respectively (effective per 19 January 2018). These decisions were in line with analyst forecasts.

Bank Indonesia also decided to accelerate the implementation of average minimum reserve requirement ratios in an attempt to increase the effective transmission of monetary policy, support banks liquidity management flexibility, while simultaneously accelerating financial market deepening in Southeast Asias largest economy.

Indonesia-based conventional commercial banks are still obliged to keep 6.5 percent of their deposits, in rupiah currency, at the central bank (known as the minimum reserve requirement) over a two-week period. However, on a daily basis the average minimum reserve requirements portion is loosened to 4.5 percent (from 5 percent previously) of their deposits, implying a higher degree of flexibility for banks.

Meanwhile, the minimum reserve requirement for conventional banks foreign deposits was loosened to a daily minimum of 6 percent, but there two-week average still needs to be at least 8 percent of (foreign) deposits. Lastly, for commercial sharia banks and sharia business units (which comply with Islamic principles), of which the total minimum reserve requirement is 5 percent of deposits over a two-week period, the central bank introduced an average daily reserve requirement of 2 percent of deposits.

Bank Indonesia also implemented two other regulations in an effort to encourage banks liquidity management. Firstly, it converted the loan-to-funding ratio (LFR) policy for conventional commercial banks and the financing-to-deposit ratio (FDR) policy for sharia commercial banks as well as sharia business units into the macro-prudential intermediation ratio (MIR) within the target range of 80-92 percent, while also broadening credit/financing components which incorporates deposit components by including bank-purchased securities and broadening deposit components by including securities published by sharia commercial banks and business units.

Secondly, Bank Indonesia converted the secondary minimum reserve requirement for conventional commercial banks into the macro-prudential liquidity buffer (MLB) and applies this MLB for commercial sharia banks at 4 percent of deposits, allowing 2 percent of deposits to be used as repo to Bank Indonesia in certain conditions to fulfill banks liquidity. Both macro-prudential instruments have counter-cyclical qualities that can be adjusted in line with economic and financial cycles.

Bank Indonesia also stated that is sees strengthening economic fundamentals in the Indonesian economy, reflected by low inflation (over the past three years), a healthy current account balance, an influx of non-resident capital flows, a stable rupiah exchange rate, an all-time high position of reserve assets and maintained financial system stability. Bank Indonesia believes that this economic context - including global economic gains - forms a great opportunity to create stronger and more sustainable domestic economic growth through sound structural reforms.

However, several risks (both external and domestic risks) remain. External risks include monetary policy normalization in several advanced economies, geopolitical tensions and the rising global crude oil price. Domestic risks include ongoing corporate consolidation, sluggish bank intermediation and rising inflationary pressures.

Global economic recovery has persisted, while international commodity prices have remained high. Global economic growth in 2018 is projected at more-or-less the same pace as in 2017, with the sources of growth originating from developing economies.

In advanced economies, the US economic recovery continues on the back of consumption and investment. In line with this, the Federal Reserve is expected to hike the Federal Funds Rate (FFR) again, while continuing to unwind its balance sheet on schedule. On the other hand, the economic recovery in Europe remains overshadowed by political risks in the region. Economic moderation is projected in Japan in 2018 due to the ageing population and restrained fiscal space.

In the developing countries, Chinas economy is expected to slow in 2018 on weaker investment growth due to tighter policy in the property sector, coupled with deleveraging. Indias economy is expected to begin a recovery as the effects of demonetization and the new GST structure fade (GST is one indirect tax for the whole nation). Overall, there is the potential of higher global economic growth, especially stemming from the recent tax reforms that stimulates the US economy. The ongoing global recovery will edge up world trade volume and international commodity prices, including crude oil, beyond the levels recorded in 2017.

Indonesias economic growth in Q4-2017 is estimated to remain stable, followed by an expected rise in 2018. In the fourth quarter of 2017, export performance of Indonesia is expected to be lower than that in the third quarter amid relatively high imports growth, especially oil & gas imports. On the demand side, investment improved on the back of government-led infrastructure projects and the expanding role of private investment.

Indonesian Rupiah versus US Dollar (JISDOR):

Low inflation was maintained in full-year 2017, keeping the figure within the target corridor of 3 - 5 percent (y/y). CPI inflation stood at 0.71 percent (m/m) in December 2017 and at 3.61 percent (y/y) for the full year. Consequently, inflation over the past three years has consistently been maintained within the target corridor. Low core inflation and weak inflationary pressures on volatile foods as well as the managed impact of various tariff hikes in the form of administered price adjustments have contributed to controlled inflation in 2017. Furthermore, positive supply and demand factors, mild external pressures as well as close policy coordination between Bank Indonesia and the central government and Regional Administrations have also supported controlled inflation in 2017. Bank Indonesia predicts that Indonesias inflation will remain within the target range for 2018, namely 2.5 - 4.5 percent (y/y).

Financial system stability was maintained in Indonesia despite a sub-optimal bank intermediation function. Such developments were reflected by a high capital adequacy ratio (CAR) in the banking industry, at 23.2 percent, and liquidity ratio, at 22.3 percent, recorded in November 2017. Meanwhile, in line with efforts to strengthen banking credit risk management, non-performing loans (NPL) stood at 2.89 percent (gross) or 1.25 percent (net).

Monetary policy easing was successfully transmitted through the interest rate channel as the banks continued to lower deposit and lending rates, albeit smaller than expected. Transmission through the credit channel has not yet been optimal in line with soft demand for new loans and the selective nature of banks when disbursing new loans. Consequently, credit growth in November 2017 declined from 8.5 percent in October to 7.5 percent. Despite restrained credit growth, economic financing through the financial markets, including issuances of stocks, bonds and medium-term notes, maintained robust growth at 29.7 percent (y/y) in November 2017.

Notwithstanding, the banking industry reported that deposit growth had decelerated from 11.0 percent (y/y) to 9.8 percent (y/y) in November 2017. For the year, therefore, deposit and credit growth achieved 9.0 percent (y/y) and 8.0 percent (y/y), respectively. Congruent with increasing economic activity and the impact of previous monetary and macro-prudential policy easing, coupled with corporate and banking industry consolidation, Bank Indonesia predicts stronger deposit and credit growth in 2018, reaching the range of 9.0 - 11.0 percent (y/y) and 10.0 - 12.0 percent (y/y) respectively.

Source: Indonesia Investments

Jan 20, 2018