Grace Sihombing and Claire Jiao – Indonesia's central bank delivered a bigger-than-expected interest rate hike to cool inflation that it now expects to surpass 6% this year amid a weakening rupiah.
Bank Indonesia raised the seven-day reverse repurchase rate by 50 basis points to 4.25% on Thursday, a move seen by only 7 of 37 economists, most of whom predicted a 25-basis point hike. Last month, Governor Perry Warjiyo also surprised with a quarter-point hike when he was expected to hold.
"The decision to increase interest rates is a front loaded, pre-emptive, and forward looking step to lower inflation expectations and ensure core inflation returns to the target of 2%-4% in the second half of 2023, as well as to strengthen the rupiah stabilization policy," Warjiyo said.
A half-point increase would enable policy makers to bring core inflation that's expected to peak at 4.6% at year-end to ease below 4% by the third quarter of 2023, Warjiyo said at the briefing. Headline inflation is seen to peak above 6% by end-2022 from 4.69% in August, reflecting the impact of the recent fuel price increase, he said.
Bank Indonesia's most aggressive rate hike since mid-2018 came as the rupiah weakened past 15,000 per dollar after the Federal Reserve's hike and hawkish signal. Although relatively resilient compared to peers, Indonesia's currency weakness increases the risk of imported inflation at a time when prices are already under pressure from the government's move to wind down some fuel subsidies.
No aggressive hikes
Governor Warjiyo remains sanguine, noting that the government can help forestall second-round effects. "Our inflation can also be controlled relative to other countries," he said. "More aggressive rate hikes are not needed in Indonesia."
Expectations for economic growth to come in at the higher end of a 4.5%-5.3% forecast range allows the central bank room to focus on controlling inflation, which analysts see crossing 7% level in the coming months following the fuel price hike.
Warjiyo reiterated that BI will stabilize the rupiah in line with fundamentals. The currency has lost about 5% against the dollar this year, making it one of the better performers in Asia where the South Korean won and Japanese yen have notched up losses of exceeding 15%.
While strong commodity exports have lent support to the rupiah, a weakening global demand could narrow the current-account surplus and add to the currency's vulnerability.