On 17th March 2016, Indonesia’s central bank, Bank Indonesia, announced a further cut of its benchmark interest rate by 25 basis points to 6.75%. This move marks the third consecutive interest rate cut in as many months and is indicative of the bank’s more confident stance as a result of the reduced volatility of the rupiah and low headline inflation; yet it also reflects the dire need to increase lending so as to re-energise consumer spending and reinvigorate the economy. In line with this, the bank reduced its lending facility to 7.25% from 7.5% previously, while its deposit facility rate has also been lowered to 4.75% from 5%.

This widely anticipated move by Bank Indonesia is part of a broader effort to make Indonesia’s interest rate more competitive vis-à-vis its regional neighbours. Indonesia, even taking into account the most recent cut, has one of the highest interest rates in the ASEAN compared to 1.5% in Thailand or 4% for the Philippines. It also comes at a time when ASEAN economies are preparing themselves for increased regional integration against a backdrop of slowing demand from China which is one of the region’s main trading partners. President Joko Widodo has clearly indicated to central bankers that he wishes to make interest rates ‘fall, fall, fall and keep falling’ and provide monetary stimulus to the country as GDP growth remains sluggish at around 5%; its lowest rate since 2009.

The poor performance of the Indonesian rupiah, which lost some 40% against the US dollar over the course of 2014 and 2015, had placed Bank Indonesia in a challenging position about the timing of providing a more accommodating monetary policy. Throughout 2015, it held back from the policy; however, the strengthening of the rupiah to the dollar since the start of 2016, the easing of inflation below target range and the Federal Reserve’s announcement to hold rates as they are for the foreseeable future provided the necessary security to move ahead.  

As advanced economies such as Japan take the controversial measure of introducing negative interest rates (since January 2016) so as to pressure commercial banks into lending to the real economy, Indonesia is significantly behind the curve when it comes to monetary policy within the realities of the global economic landscape. Lending rates by commercial banks are prohibitively high at a time when the government needs to be encouraging local companies to invest, in turn creating new jobs and ultimately driving consumptive spending. Local manufacturers also have an opportunity to take advantage of the weakened currency to gain an advantage in global export markets, provided that they make the necessary investments to offer greater efficiency for sustainable competition.

The latest cut to the interest rate, coupled with measures introduced by Bank Indonesia in February to reduce the reserve requirement ratio for lenders by 100 basis points to 6.5% are all encouraging signs for investors in Indonesia. Signalling an end to the central bank’s cautious stance, what investors are now hoping for is a more aggressive approach to monetary policy. This must materialise in the form of a more substantial cut in the interest rate, provided that the rupiah and inflation remain on track, coupled with policies to get banks lending to the real economy and shifting away from their reliance on high margin lending both to consumers and to commodity-focused industries. 

Global Business Guide Indonesia - 21st March 2016

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)

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