Indonesian central bank kept its key interest rate on hold today. The 7-day policy reverse repo rate remained at 4.25 percent. The central bank’s narrative did not change much. It continued to project 2018 GDP growth at 5.1 percent to 5.5 percent, inflation in the target range, and the current account deficit at 2 percent to 2.5 percent of GDP.
According to an ANZ research report, the central bank’s decision to maintain the policy rate at 4.25 percent. Although the first quarter inflation at 3.3 percent year-on-year was below the mid-point of the central bank’s target range of 2.5 percent to 4.5 percent and GDP has been growing by only slightly above 5 percent year-on-year, the scope for further cuts in the policy rate is negligible. The main reason is the need to guarantee financial market stability from tightening by the U.S. Fed. This precautionary need has been accentuated by the structurally high foreign holdings of local currency bonds.
The average credit growth of 7.9 percent year-on-year in the first two months of the year is quite short of the official target of 10 percent to 12 percent. However, a lower policy rate by itself is unlikely to boost credit. A stronger monetary policy transmission mechanism is likely to be more effective. To this degree, BI has already announced some flexibility in bank reserve requirements from June. This is expected to boost the banking system’s capability to better manage its liquidity position.
Indeed, some of the past measures to bolster the transmission mechanism are becoming clear, commercial lending rates have fallen although still not in complete lockstep with the policy rate. The latest Banking Survey indicates towards some acceleration in credit in the months ahead, on the back of a continued pullback in lending rates.
“We stand by our view that monetary policy will remain neutral with BI maintaining its 7-day reverse repo rate at 4.25% through 2018”, added ANZ.
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