Rate hike tipped to boost rupiah

Indonesia may see another downturn in economic growth after Bank Indonesia (BI) started a liquidity tightening campaign last Thursday by raising its key interest rate to contain inflation and stabilise the rupiah.

The central bank’s decision to push up the interest rate is expected to halt the fall in the rupiah, which has been under pressure amid the withdrawal of foreign funds from the bond and equity markets in the last several days.

Bank of America Merrill Lynch economist Hak Bin Chua said the higher interest rate would prevent the rupiah from falling further. But the move would hurt investment and domestic demand, which would in turn affect growth, Chua added.

BI Deputy Governor Perry Warjiyo acknowledged the new policy rate would drag down the GDP growth. “Following the hike, the tendency will be for our full-year economic growth to head toward 6.1 per cent,” Perry told reporters after the central bank’s monthly board of governors meeting.

The government proposes to revise down its growth target to 6.3 per cent, from 6.8 per cent in the 2013 State Budget. The central bank has recently been under pressure to increase the interest rate to help contain inflation and reverse the weakening trend of the rupiah. BI has estimated that inflation might hit 7.8 per cent this year – well above its target of 5.5 per cent – while last week the rupiah weakened below its psychological level of 10,000 per US dollar (Bt31).

Representatives from the business community said that the decision by BI’s newly appointed governor Agus Martowardojo to raise the key interest rate signalled a possible end of the low interest rates regime championed by former central bank governor Darmin Nasution.

“Banks will soon adjust to the policy by increasing their credit interest rate, and this will affect our business by creating additional costs,” said Sofjan Wanandi, the chairman of the Indonesian Employers’ Association (Apindo).

Credit Suisse economist Robert Prior-Wandesforde argued that the move signalled that BI, under Agus’s leadership, might be shifting gears into “hawkish”, a term coined for a central bank prioritising stability rather than economic growth. 

“The big question ... is whether the same actions would have been taken by the previous BI Governor,” he wrote in a research note.

Finance Minister Chatib Basri shared a different view, saying that 25 basis points of the BI rate hike “would not affect much” of the economic expansion. In contrast, it would help contain inflationary pressure, eventually leading to stronger household 

consumption, he said.