While there are indications that domestic demand in Indonesia - which has so far been propping up the economy - is showing signs of weakening, BI would have little monetary policy space to cut rates just to prop up demand. While the nominal interest rate environment appears to be high, the real policy rate is quite low - even by historical standards.
With inflation hardening in April and remaining far above BI's comfort zone, any rate cut would be counter productive. The already weak currency would then be further impacted, thereby likely affecting the confidence of foreign investors.
Indonesia's current account deficit for the year will likely remain high and unsustainable - and financing it will remain a challenge as capital outflow looms. Also, with corporate debt accounting for more than half of Indonesia's total external debt, a weakening currency can have a telling impact on corporate profitability. Given this, we believe BI would do well to keep the rate unchanged rather than opt for a cut.
