Eyes on Bank Indonesia’s policy statement

Expect Bank Indonesia (BI) to keep its key BI rate unchanged on Tuesday. While the October policy statement sounded dovish, there seemed to be little conviction whether a rate cut is necessary at this juncture. Recent comments from the Finance Minister, who suggested that a rate cut may weigh on financial system stability, have eased some pressure on the central bank to loosen its policy stance. 

The outlook for the rupiah remains the crux of the matter. That BI is no longer tolerant of a weak rupiah is clear from the persistent intervention in the markets. And it is easy to explain why. Import content of production is high at an estimated circa 60-70%, on average, across industries. A weak rupiah has been a drag on overall investment growth and will continue to be. At the same time, a weak rupiah is unlikely to boost export growth, given that Indonesia is still heavily reliant on commodity exports. The -21% (YoY) export growth in October is a timely reminder on this front. 

Any action that keeps the rupiah steady is therefore geared towards bolstering GDP growth. Given the uncertainties with regards to the US Fed rate hike (and the pace of adjustment), avoiding a rate cut at this juncture is presumably the safe choice. Caution should prevail on the outlook of Indonesia's external balances next year. While C/A deficit has narrowed to 2% of GDP this year, expect it to widen again in 2016 if there is a significant recovery in investment growth. External financing risks may haunt the domestic markets once again next year. 

BI may keep rates unchanged this month but focus on the policy statement. The central bank may continue to lean on the dovish side, which makes it interesting to wonder what will BI do in December. CPI inflation is likely to slip well below 5% (YoY) in December, mostly due to base effects, but will certainly provide a justification for a cut.