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Interest Rate Dilemma

Where does the dilemma truly lie? Previously, BI 7 DRRR has increased twice, by 25 bps each, in two consecutive weeks: on May 17 and again on May 30. At the time, the reference rate was 4.75 percent. On the one hand, by increasing its reference rate, BI wants to withhold capital outflow from the local financial market.

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Foreign currencies adorn the walls outside of a money changer at a shopping center in Kuningan in Jakarta on Tuesday (29/5/2018). The exchange rate of the rupiah against the US dollar weakened to Rp 14,500.

Bank Indonesia (BI) increased its seven-day reverse repo rate (BI 7 DRRR) by a relatively significant 50 basis points (bps), from 4.75 percent to 5.5 percent, on June 29. This was in response to the United States Federal Reserve increasing its reference rate, or Fed Fund Rate (FFR), by 25 basis points from 1.75 percent to 2 percent on June 14. BI’s policy immediately led to the strengthening of the rupiah’s exchange rate, despite it still being lower than the psychological barrier of Rp 14,000 per US dollar. Will the BI 7 DRRR continue to follow FFR’s increase? This is where the interest rate dilemma begins. How should we resolve this?

Long ago, I had predicted that such a dilemma would emerge. Therefore, BI must anticipate any change of FFR that may affect BI’s reference rate, or BI 7 DRRR. This will give way for a dilemma. If FFR is increased three times, it is highly likely that the BI 7 DRRR will not survive. This can significantly increase capital outflow and weaken the Rupiah’s exchange rate. On the other hand, BI wishes to help the government reach its target of a one-digit credit interest rate (Paul Sutaryono, Kompas, 3/3/2018).