Fitch: Indonesia Rate Cut Not Likely To Boost Lending Soon

Bank Indonesia's 25bps rate cut last week signals a more pro-growth monetary policy stance, but is not likely to significantly boost bank lending growth in the near term, says Fitch Ratings.

Subdued GDP growth and lower headline inflation have contributed to the decision by Bank Indonesia to cut the benchmark rate to 7.25%. But this may expose the rupiah to further weakening, after it has already depreciated by over 10% since the beginning of 2015. Indonesia's external balances remain a weakness compared to peers, in part as a result of the country's higher commodity dependence. The current account deficit has narrowed substantially since the "Taper Tantrum" of 2013, when Indonesia's capital markets experienced a high degree of volatility. But low FDI inflows, large foreign ownership of government bonds and growing external debt mean the country remains vulnerable in the event of a renewed bout of foreign investor uncertainty.

It is not yet clear to what extent the shift in Bank Indonesia's policy stance in favour of growth would come at the expense of stability. Fitch continues to highlight that the authorities' ability to maintain macroeconomic stability is a key factor for Indonesia's sovereign creditworthiness. Monetary policy will be particularly relevant in this regard and Bank Indonesia's cautious stance in most of 2015, in addition to the low public debt burden, has helped Indonesia weather periods of market turbulence. One of the key questions now is whether the authorities will be tempted to use a significant part of the foreign exchange reserves to counter depreciation in the rupiah in the coming months.

This rate cut alone is unlikely to be sufficient to boost bank lending growth, which Fitch expects will remain in the low teens for the third consecutive year in 2016. Fitch recently downgraded the Indonesian banking sector's outlook to negative from stable in line with an increasingly challenging operating environment.

Bank asset quality and profitability should remain under pressure with NPLs rising further to 3.5% by end-2016, with weakness concentrated in the mining sector. Rising "special- mention" loans in 2015 confirm that asset quality pressures have already begun to rise.

Large banks are in a stronger position to weather the increasingly challenging environment with stronger liquidity profiles and higher core capital. Sector Tier 1 capital stood at 18.2% at end-August 2015, which, along with large banks' relatively high profitability, indicates sufficient buffers against large spikes in credit losses. More robust deposit and lending franchises also mean the larger banks have a higher loss-absorption capability and their profitability should be better protected compared to mid-tier lenders.