Natixis - Nipping the bud of lira spillover, Indonesia hiked rates, as we expected

Author: Judith Huismans

·         Indonesia had a choice today and the central bank safeguarded financial stability by raising rates by 25bps to 5.5%, against market expectations (Natixis called for a hike). We argued in a previous notethat emerging Asian central banks not only have better macro-economic fundamentals than Turkey’s but also are much more vigilant in ensuring price stability. Today, Indonesia showed that it is committed to price stability through its hawkish tone and a 25bps rate hike, even as inflation remains stable.

 

·         Because Bank Indonesia (BI), similar to other EM Asian central banks, learned a hard lesson during the Asian Financial Crisis, they have taken steps since to ensure sound macro-economic fundamentals such as having ample reserves, manageable current account deficits, contained exposure to foreign exchange debt, and most importantly, take actions necessary to maintain stability.  

 

·         Specifically, Indonesia has three reasons why it needed to hike. First, the central bank understands that its widened current account deficit in Q2 2018 is not sustainable, and second, with foreign capital getting more discriminating, Bank Indonesia needed to act. As such, the rate hike kills two birds with one stone – it rebalances the current account towards a more sustainable level and also adds more juice to Indonesia’s yield, supporting inflows. 

 

·         Third, although Indonesia’s government debt as a share of GDP is the lowest in Asia and the share of foreign exchange debt is getting smaller, it still has about 20% of GDP exposure. This means that a stable IDR also maintains debt sustainability. And most importantly, even though CPI remains within target, a weaker rupiah would add to inflationary pressures, and something that BI wants to pre-emptive nip in the bud potential spillover. 

 

·         And this is why EM Asia has been more resilient and will continue to be against the backdrop of tighter USD liquidity – central banks in the region are certainly making it clear that they prioritize price stability by doing what’s necessary to instill investors’ confidence. Therefore, emerging Asia is in a strong position to ride out the storm thanks to already ample buffers, and most importantly, steady captains at the helm of the ship, such as BI today.

 

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