Bank Indonesia Holds Policy Rate: Economic Resilience Improves, Recovery Prospect Continues

​No. 20/6/DKom

The BI Board of Governors agreed on 17th and 18th January 2017 to hold the BI 7-day Reverse Repo Rate at 4.25%, while maintaining the Deposit Facility (DF) and Lending Facility (LF) rates at 3.50% and 5.00% respectively, effective 19th January 2018. The policy is consistent with the well maintained macroeconomic and financial system stability, while also building domestic economic recovery momentum.

In addition to the decision regarding policy rate, the BI Board of Governors also decided to accelerate the implementation of average minimum reserve requirement ratios as a follow up on the monetary policy operational framework reform. Those refinements seek to increase the enhance the effective transmission of monetary policy, supporting banking liquidity management flexibility, while simultaneously accelerating financial market deepening (Attachment 1). In total, conventional commercial banks are obliged to keep 6.5% of deposit's worth of minimum reserve requirement in Rupiah. Out of this number, the average minimum reserve requirement's portion is loosened from 1.5% to 2% of deposit. Meanwhile, from conventional banks' total minimum reserve requirement in forex, which is 8% of deposit, the average reserve requirement of 2% is implemented. For commercial shari'a banks and shari'a business units, of which the total minimum reserve requirement is 5% of deposit, the average reserve requirement is set at 2% of deposit.

To encourage bank intermediation function and liquidity management, the Board of Governors also decided to refine the macroprudential policy by implementing two regulations. Firstly, converting the Loan to Funding Ratio (LFR) policy for conventional commercial banks and the Financing to Deposit Ratio (FDR) policy for shari'a commercial banks and shari'a business units into Macroprudential Intermediation Ratio (MIR) within the target range of 80-92% while also broadening credit/financing components which incorporates deposit components by including bank-purchased securities and broadening deposit components by including securities published by shari'a commercial banks and business units. Secondly, converting the secondary minimum reserve requirement for conventional commercial banks into Macroprudential Liquidity Buffer (MLB) and applying MLB for shari'a commercial banks at 4% of deposit, allowing 2% of deposit to be used as repo to Bank Indonesia in certain conditions to fulfill bank's liquidity. Both macroprudential instruments have countercyclical qualities that can be adjusted in line with economic and financial cycle (Attachment 2).

Bank Indonesia is confident that national economic resilience is improving in Indonesia, as reflected by the achievement of low inflation over the past three years, a healthy current account, an influx of non-resident capital flows, a stable rupiah exchange rate, an all-time high position of reserve assets and maintained financial system stability. Moving forward, with the ongoing global economic gains and maintained national economic stability, Bank Indonesia acknowledges a great opportunity to create stronger and more sustainable domestic economic growth through sound structural reforms. Several risks still remain vigilance, both external risks which includes monetary policy normalisation in several advanced economies, geopolitical tensions and the rising global oil price, as well as the domestic risks, such as ongoing corporate consolidation, sluggish bank intermediation and inflation risk. To that end, Bank Indonesia constantly optimises its monetary, macroprudential and payment system policy mix to strike an optimal balance between macroeconomic and financial system stability against the current economic recovery process. Furthermore, Bank Indonesia also continuously strengthens policy coordination with the Government to maintain macroeconomic and financial system stability.

The global economic recovery has persisted, while international commodity prices have remained high. Global economic growth in 2018 is projected at approximately the same pace as in 2017, with the sources of growth originating from developing economies. In advanced economies, the US economic recovery continues on the back of consumption and investment. In line with this, the Fed is expected to hike the Federal Funds Rate (FFR), while continuing to unwind its balance sheet on schedule. On the other hand, the economic recovery in Europe remains overshadowed by political risks in the region. Economic moderation is projected in Japan in 2018 due to the ageing population and restrained fiscal space. In the developing countries, China's economy is expected to slow in 2018 on weaker investment growth due to policy to tighten the property sector coupled with deleveraging. India's economy is expected to begin a recovery as the effects of demonetisation and the new GST structure fade. Overall, there's a potential of a higher global economic growth, especially stemming from the recent tax reforms that stimulates the US economy. The ongoing global recovery will edge up world trade volume and international commodity prices, including oil, beyond the levels recorded in 2017.

Indonesia's economic growth in the fourth quarter of 2017 is estimated to remain stable, with an expected rise in 2018. In the fourth quarter of 2017, export performance is expected to be lower that the third quarter amid a relatively high imports growth, especially oil and gas imports. On the demand side, investment improved on the back of government infrastructure projects and the expanding role of private investment. Meanwhile, consumption growth remains sluggish. Consequently, the national economy is forecasted to grow in 2017 at 5.1%. Nevertheless, economic growth is projected to accelerate in 2018 in line with stronger domestic demand as investment increases along with household consumption and fiscal stimuli. Meanwhile, vibrant export growth is predicted for 2018 as the global economy continues to recover and international commodity prices remain high. In general, economic growth in 2018 is projected in the 5.1-5.5% range.

The balance of payments is expected to record a surplus in the fourth quarter of 2017, while the current account deficit remains under control. The BOP surplus has been bolstered by a significant capital and financial account surplus, stemming primarily from direct investment and portfolio investment. Nonetheless, the current account deficit is expected to expand from the previous period along with a narrower non-oil and gas trade surplus as well as larger oil and gas trade deficit and services account deficit. Consequently, the position of reserve assets at the end of December 2017 stood at USD130.2 billion, representing an all-time high and equivalent to 8.6 months of imports or 8.3 months of imports and servicing government external debt, which is well above the international adequacy standard of three months. Looking ahead, the current account deficit in 2018 is expected to remain under control in the 2.0-2.5% of GDP range in line with national economic growth.

The rupiah has remained stable in 2017. For the year, the average daily rupiah exchange rate has remained relatively stable with slight depreciation recorded at 0.60% to Rp13,385/USD. A deluge of non-resident capital flows drawn to Indonesia on favourable global and domestic dynamics has supported rupiah stability. Externally, the relatively conducive global financial markets have pushed foreign capital flows to developing economies, including Indonesia. On the domestic side, however, positive sentiment stemmed from Indonesia's upgraded credit rating, controlled inflation and competitive returns on domestic financial assets, are factors which attracted non-resident capital into the country. Nevertheless, the rupiah confronted pressures from monetary policy normalisation, growing expectations of an FFR hike and the US tax reform plan. In December 2017, the rupiah was relatively stable, however, falling just 0.24% (mtm) on cyclical domestic financial market factors, namely a spike in demand for foreign exchange by residents to repay external debt and fund imports, along with the profit realisation of non-resident investors. Bank Indonesia will continue to monitor global financial uncertainty risk and persist with exchange rate stabilisation measures in line with the currency's fundamental value, while maintaining market mechanisms.

Low inflation has been maintained in 2017 within the target corridor of 4±1%. CPI inflation stood at 0.71% (mtm) in December 2017 and at 3.61% (yoy) for the year. Consequently, inflation over the past three years has consistently been maintained within the target corridor. Low core inflation and weak inflationary pressures on volatile foods as well as the managed impact of various tariff hikes in the form of administered prices have contributed to controlled inflation in 2017. Furthermore, positive supply and demand factors, mild external pressures as well as close policy coordination between Bank Indonesia and the Central Government and Regional Administrations have also supported controlled inflation in 2017. Bank Indonesia predicts inflation to remain within the target range for 2018, namely 3.5±1%. Nonetheless, Bank Indonesia shall constantly monitor the risk of rising inflation. In addition, Bank Indonesia will strengthen policy coordination with the central and local governments.

Financial system stability has been maintained despite a suboptimal bank intermediation function. Such developments were reflected by a high Capital Adequacy Ratio (CAR) in the banking industry, at 23.2%, and liquidity ratio, at 22.3%, recorded in November 2017. Meanwhile, in line with efforts to strenghten banking credit risk management, non-performing loans (NPL) stood at 2.89% (gross) or 1.25% (net). Monetary policy easing was successfully transmitted through the interest rate channel as the banks continued to lower deposit and lending rates, albeit smaller than expected. Transmission through the credit channel has not yet been optimal in line with soft demand for new loans and the selective nature of banks when disbursing new loans. Consequently, credit growth in November 2017 declined from 8.5% the month earlier to 7.5%. Despite restrained credit growth, economic financing through the financial markets, including issuances of stocks, bonds and medium-term notes (MTN), maintained robust growth at 29.7% (yoy) in November 2017. Notwithstanding, the banking industry reported that deposit growth had decelerated from 11.0% (yoy) to 9.8% (yoy) in November 2017. For the year, therefore, deposit and credit growth achieved 9.0% (yoy) and 8.0% (yoy) respectively. Congruent with increasing economic activity and the impact of previous monetary and macroprudential policy easing, coupled with corporate and banking industry consolidation, Bank Indonesia predicts stronger deposit and credit growth in 2018, reaching 9.0-11.0% (yoy) and 10.0-12.0% (yoy) respectively.

Jakarta, 18 January 2018
Communication Department

Agusman
Executive Director