Lower Interest Rate Expected to Accelerate Economic Recovery

KOMPAS/PRIYOMBODO

Residents cross in front of the Bank Indonesia fence to access the Bank Indonesia area in Jakarta, Thursday (21/02/2019).

JAKARTA, KOMPAS - Bank Indonesia (BI) is optimistic that the lower benchmark interest rate can accelerate the recovery of the national economy, which has been severely affected by the COVID-19 pandemic. Loans are expected to grow and foreign fund inflow will also increase.

BI decided to lower its seven-day reverse repo rate by 25 basis points (bps) to 3.75 percent from 4 percent during its board of governors’ meeting was held in Jakarta on Nov. 18-19. The benchmark rate is the lowest since the central bank changed its seven-day repo rate on Aug. 19, 2016.

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BI also lowered the rupiah deposit facility and lending facility interest rates by 25 bps to 3 percent and 4.5 percent, respectively.

BI Governor Perry Warjiyo said in Jakarta on Thursday that the central bank cut its benchmark interest rate on the back of an improvement of the global economy.  In the third quarter, the economy of a number of countries, including Indonesia, began to recover.

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"Economic indicators have showed an improvement, starting from the mobility of the global community, the performance of the service and manufacturing industries, to the optimism of industry players," he said at a press conference in Jakarta.

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Development of BI Reference Rate 7- Day Reverse Repo Rate / Source: Bank Indonesia

Perry hoped that banks would be able to lower their lending rates to help stimulate economic recovery. From January to November, BI cut its benchmark interest rate by 125 basis points. Meanwhile, since July 2019, the central bank has lowered the benchmark interest rate by 225 basis points.

"It is time for the banks to see that the economic recovery is continuing. This can be seen from signs of recovery in industries and corporations, especially those that are export-oriented,” he said.

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According to Perry, banks need to build a sense of optimism in channeling their loans as demand has begun to increase. BI has also increased bank liquidity through a quantitative easing policy to a total of Rp 680.89 trillion (US$48.63 billion) as of Nov. 17. The rise was due to the decline in the primary reserve requirement (GWM) by about Rp 155 trillion and a monetary expansion of around Rp 510.09 trillion.

However, BI is aware that it will take time for banks to adjust their lending rate to the cut. In order to be able to reduce their lending rates, banks rely on a number of factors such as the benchmark rate, administrative costs and credit risk premium.

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"Perceptions of credit risks, to some extent, have caused a delay in the lowering of banks’ lending rates. The risk also causes banks to increase their reserve requirements," said Perry.

BANK INDONESIA UNTUK KOMPAS

Governor of Bank Indonesia Perry Warjiyo

Capital flow

Perry said he was optimistic that foreign capital inflows into the country would further increase in 2021. During October-November, foreign capital inflows reached $3.68 billion.

Meanwhile, Josua Pardede, an economist at Bank Permata, said the expected increase could not be separated from the growing optimism in the global financial market along with the positive development of the United States presidential election and vaccines.

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Under normal conditions, a reduction in the benchmark interest rate causes a decline in yield gaps between government securities in a developing country and those in developed countries. This will in turn reduce the price of debt securities.

"However, in the midst of the expected increase in stimulus in the US, investors and market players in the US will switch to debt securities in developing countries, one of which is Indonesia’s SBN [government securities]," Josua said.

According to a statement issued by the director general of funding and risk management at the Finance Ministry’s Funding and Risk Management, the government is still offering a coupon rate or yield of up to 6.3 percent for retail debt securities despite a decline in BI\'s benchmark interest rate.

The coupon rate has not changed because the factor in determining the rate is based on the minimum coupon rate, so the yield on the debt securities will not change from the rate when it was first launched, which was  6.3 percent.

With the small impact expected from the rise in interest rate in 2022, the prospects of the bond market next year is quite promising.

However, the rate of investment returns will be higher if BI\'s benchmark interest rate rises above 5 percent. The head of investment research at Infovesta, Wawan Hendrayana, estimates that the BI benchmark rate will not increase in 2021. With the country’s inflation rate projection of below 2 percent, BI will even be able to cut its benchmark rate again next year.

"With the small impact expected from the rise in interest rate in 2022, the prospects of the bond market next year is quite promising," he said.