BI Still has Room to Maintain Interest Rates

KOMPAS/RADITYA HELABUMI

An officer shows the US dollar currency at the cash center of Bank Mandiri, Jakarta, Tuesday (5/4/2022).

JAKARTA, KOMPAS — Bank Indonesia (BI) is believed to still have room to maintain its benchmark interest rate, even though the United States central bank, the Federal Reserve (the Fed), raised its benchmark interest rate by 50 basis points on Wednesday (4/5/2022) local time. It is predicted that the increase in the Fed’s interest rate will not trigger a significant capital outflow from within the country, even though BI did not immediately respond to the Fed's move.

Bank Mandiri economist Faisal Rachman, on Thursday (5/5), said that there is no need for BI to rush to raise its benchmark interest rate following the Fed's rate hike.

"BI still has room for the BI benchmark interest rate to remain at 3.5 percent for some time," said Faisal.

Faisal said that the room for BI to maintain such low interest rates is related to the current, supportive account balance conditions, so that the central bank can still maintain the movement of the rupiah exchange rate at its fundamental level.

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According to him, the fairly solid current account balance is caused by good export performance due to soaring prices for Indonesia's mainstay export commodities, such as coal, rubber and crude palm oil.

BI's move to raise interest rates should not look at external conditions, but at domestic inflation. According to Faisal, inflation, which indicates a warming domestic economy, is expected to occur in the second half of this year. He estimated that BI's benchmark interest rate will increase several times to a total of 75 basis points. Therefore, the benchmark interest rate at the end of 2022 will be at the level of 4.25 percent.

Meanwhile, the research director of the Center of Reform on Economics (CORE) Indonesia Piter Abdullah Redjalan explained on Thursday that before the COVID-19 pandemic, the Fed's interest rate hikes would usually trigger a significant capital outflow if BI did not take the same action by raising interest rates.

Foreign investors who had assets denominated in rupiah, such as stocks and state securities (SBN), would shift their funds to the US financial market, which is considered more profitable.

This happened because before the COVID-19 pandemic, many foreign funds were in the form of hot money, because investors only held short-term assets. Capital flight would cause the rupiah exchange rate against the US dollar to depreciate.

However, after the pandemic, the share of foreign ownership in SBN and stocks continued to decline, thereby significantly reducing fears of capital flight. Citing data from the directorate general of Financing and Risk Management at the Finance Ministry, the total foreign ownership in SBN up to April 27, 2022 was Rp 831.87 trillion (US$57,456,251.88), equivalent to 17.11 percent of the total SBN of Rp 4,860 trillion. Before the pandemic, the share of foreign ownership of the total SBN amounted to almost 40 percent.

Indonesia's foreign exchange reserves are in a strong position to maintain the stability of the rupiah exchange rate.

Therefore, even if there is capital flight, the amount will not be significant, and it will not disrupt the stability of the domestic financial system.

Moreover, said Piter, Indonesia's foreign exchange reserves are in a strong position to maintain the stability of the rupiah exchange rate. As of 31 March 2022, the value of Indonesia's foreign exchange reserves was US$139.12 billion.

This article was translated by Hyginus Hardoyo.