Flash Notes-Indonesia: Bank Indonesia Maintains Interest Rate

Bank Indonesia (BI) kept its policy rate unchanged at 7.50% today in line with consensus and our expectation. Similarly,the overnight deposit facility (FASBI) rate was kept steady at 5.50%. Volatile global market conditions and elevateddomestic inflation limit the policy options for BI in the short-term. Despite the growth slowdown, we believe that BIhas little room to cut its interest rates further in the short-term until the inflation eases in 4Q15. While there remainsrisk of a 25-50 bps interest rate cut in the fourth quarter, we are of the view that IDR weakness could continue to keepBI’s hands tied. The USD/IDR is likely to trade firmer as we head into the eventual rate lift-off in the US which is expectedin the later part of the year.

    The headline inflation rose to its highest this year at 7.26% y/y in June, up from 7.15% y/y in May. Inflation is likely toremain firm in the upcoming months but we do not expect significant upside risk from here. Instead, we expect to seesharp moderation in the headline CPI in November and December due to a high base effect.

    Growth outlook has remained weak. Indonesia’s exports contracted for the 8th consecutive month in May. In April-May, exports fell by 11.8% y/y, similar to the pace of contraction in 1Q15. Poor exports and an expected moderationin private consumption glimpsed from the motor vehicle sales, suggest that growth in the second quarter will likelyremain lacklustre. BI forecasts that the GDP growth in 2Q15 will be similar to the 4.7% in the preceding quarter whichwas the slowest growth pace since 2009. The growth outlook is expected to improve from the third quarter with anexpected increase in infrastructure spending. Our full-year growth forecast is at 5.0%, at the lower end of BI’s 5.0-5.4%forecast range.

    The current account deficit is expected to continue narrowing on the back of the import slowdown. Reflecting a narroweroil and gas deficit, Indonesia’s current account gap improved to -1.8% of GDP in 1Q15 and is expected at -2.5% in 2Q15compared to -3.9% in 2Q14.

    USD/IDR touched a 17-year high of 13,400 in June. Since the start of the year, the IDR has depreciated by around 7.1%against USD. Against the backdrop of rate normalization expectation in the US later this year, we expect USD/IDR totrade higher to 13,500 and 13,600 at end-3Q15 and end-4Q15 respectively. Soft commodity outlook could furtherweigh on the currency while the current account deficit remains a concern.