Bank of Indonesia hikes interest rate by 50bps to 7.00%

Here's why analyst calls for further rate hikes.

According to Standard Chartered, Bank Indonesia (BI) hiked the BI rate by 50bps to 7.00% at its extraordinary Board of Governors meeting on 29 August.

Here's more:

It hiked the overnight deposit facility (FASBI) rate, the lower limit of its interest rate corridor, by 50bps to 5.25%; and the repo rate, the upper limit of the interest rate corridor, by 25bps to 7.00%.

The central bank also shortened the monthly holding period for BI certificates (SBIs) to one month from six months, and entered a bilateral swap agreement with Japan.

Implications – Given these rate hikes, we are reviewing our rate forecasts. We believe further rate hikes are needed to restore market confidence amid Indonesia’s deteriorating economic fundamentals.

Although rate hikes may help to ease inflationary pressures and strengthen the Indonesian rupiah (IDR), we also note the ‘side effects’ of such policy on real GDP growth.

Rate hikes will raise financing costs for firms and may adversely affect liquidity in the banking system. However, they will help to contain inflation and preserve growth momentum in household consumption and investment.

We believe the benefits of the rate hikes will outweigh their negative impact on real GDP growth. We therefore maintain our full-year real GDP growth forecast of 5.8% for 2013.

We see the BI rate hike as a short-term positive for the IDR. However, in our view, it will not be sufficient to stabilise the IDR. We forecast USD-IDR at 12,000 at end-Q3 and recommend that real-money funds maintain maximum FX hedge ratios on the IDR.

We have turned Underweight duration on IDR bonds, from Neutral previously. We expect the curve to shift higher on today’s 50bps rate hike and expectations of further hikes this year, as well as on supply indigestion.