Time to cut:An opportunity for Bank Indonesia

Today’s GDP number has pushed us over the edge. Of our policy rate call,
that is. At5% y-o-y in 2Q, the economy wasn’t exactly firing on all
cylinders. Officials at BankIndonesia (BI) will surely have taken
notice. We have argued for some time thatpolicymakers were likely keen
to pivot to an easing bias the moment the opportunityarose (see: Bank
Indonesia Watch, 19 July). And voila, here it is.

    Inflation is heading down, structurally at least, and there may be a
temporary uptickaround the corner. Plus, the Fed hasn’t moved yet,
giving BI a narrow window tosqueeze in a cut before the balance sheet of
the US central bank begins to shrink.

www.964.net,    And then there’s growth: at 5% Indonesia is running well below
potential, hardly whatmonetary officials, or anyone in government for
that matter, would like to see.

    However, we think space to cut this year is limited and BI is
unlikely to pursue an easingcycle similar to 2016. On the one hand there
is the Fed, but on the other hand, recall thatBI will also have a lower
inflation target of 2.5-4.5% in 2018. This suggests that the centralbank
will need to be cautious as it remains fully committed to its price
stability mandate.

    However, we forecast only a limited pick-up in global growth next
year and see acontinuation of the broad global disinflation trend
(Global Economics Quarterly: The wageconundrum, 22 June 2017),
suggesting the appetite for EM assets should remain robust.

    As one of only two liquid high-yielding bond markets in EM Asia, we
believe Indonesiastands to benefit (indeed, the other one, India, just
delivered a rate cut). Although weexpect GDP to accelerate to 5.3% next
year, policymakers are unlikely to take a rest. Wetherefore see one more
rate cut in 2Q18, bringing the policy rate to 4.25%.

    Of course, rate cuts alone are unlikely to boost growth
meaningfully. Indonesia’s keyproblems are structural in nature, and the
monetary transmission is imperfect. Butwith loan growth having peaked in
April short of BI’s 10-12% target, and 2017 GDPcurrently tracking below
its 5.2-5.4% forecast, the central bank has a clearjustification to ease
monetary support to the economy.

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