beyondbrics

Indonesia defied the somber global economic climate in 2011, posting its biggest GDP growth in 15 years – so its central bank’s decision on Thursday to cut its policy interest rate by 25bp to 5.75 per cent took analysts by surprise.

Bank Indonesia – which cut the rate in October and November – said its intention was to provide “a further step to boost Indonesia’s economic growth amidst decreasing performance of the global economy”. But analysts warned that the bank was putting too much emphasis on growth and underestimating inflationary risks – which could force it to reconsider later in the year.

BI emphasised in a statement that its priority was to meet its inflation target – between 3.5 and 5.5 per cent – and ensure exchange rate stability. But it said inflation was on a downward trend, driven by falling food prices, and that the rupiah, while depreciating slightly in January, was “quite stable”. On growth, it said:

The world economic growth in 2012 is predicted at 3.3 per cent, lower than the previous forecast at 3.7 per cent. The resolution of euro area crisis related to debt and fiscal deficit will still take time and contains uncertainty, while the US economy is still facing weak recovery. This condition leads to declining global trade and affects emerging market economies, including Indonesia. In line with the weakening global economic activity, non-energy global commodity prices are in decreasing trend, and accompanied by decreasing global inflationary pressures.

But HSBC said the cut had been made against a consensus call for a pause and was “testament to BI’s indisputable growth bias”. It noted that even though Indonesia is one of the most domestically orientated and resilient economies in east Asia – and so less in thrall to global economic sluggishness – its central bank is distinctly more dovish than those in more externally exposed economies like South Korea and Malaysia.

HSBC added that this doveishness would likely lead to another rate cut:

Looking ahead, we believe that the BI will cut rates further and by a total of at least 25bp during the first half of 2012. However, we are concerned that the growth-bias is too excessive and that inflation will accelerate during the course ofthe year, ultimately necessitating a policy reversal.

Barlcays Capital also took issue with BI’s benign outlook on inflation:

We think January likely marked the bottom of inflation and look for it to rise to 4 per cent by March, given the typical rise in food prices before the harvesting season. Our base case is that the government will raise electricity prices 10 per cent in April, which will add 30bp to inflation… Overall, our view remains that inflation will rise through the year, and we are raising our end 2012 inflation forecast by 20bp to 5.5%. The risks, in our opinion, are biased to the upside given the easing by the central bank and supply-side uncertainties (food and oil). Also, Indonesia is prone to sudden food-related price spikes.

What’s more, BarCap warned the cut could weigh on the rupiah – which, already weak because of Indonesia’s modest balance of payment inflows, would continue to underperform other east Asian currencies in the short-run.

It added that  investor confidence in Indonesia could take a knock because the central bank continued to defy analyst expectations. That’s a blow for a country that only in January was declared investment grade by Moody’s – becoming the second of the three big rating agencies to do so after Fitch.

It’s worth remember that when Brazil cut rates on fears of a global slowdown in August, analysts were similarly surprised. But the slowdown came and Brazil was vindicated - and is still cutting rates.

Related reading:
Indonesia cuts rates to protect growth, FT
Indonesia: sale of the century? beyondbrics
Indonesia growth: no need to cut, beyondbrics