The Central Bank acts to stabilize the rupiah
Like many other emerging economies, the Indonesian economy has been challenged by the policy undertaken by the US Fed, which has raised its interest rates for the last few quarters and has strongly indicated it will raise the Fed Funds rate further. Being a small open economy, Indonesia is not immune to such a policy in the United States, and this is especially manifest in the weakening of the Indonesian currency, the rupiah. Therefore, when the rupiah exchange rate against US dollar crossed Rp.14,000, deemed a psychological barrier, the Indonesian Central Bank had to step in. The policy meeting was convened for two days, and at the end of the session, Governor Agus Martowardojo announced that the benchmark interest rate was increased by 25 bps, to 4.5%.
The market reacted negatively; the rupiah depreciated further. Therefore, the Central Bank indicated to take further measures to preserve stability. Prior to that decision, the discussion in the market pointed to an increase of 25 bps in the benchmark interest rate. But our own feeling was that it wouldn't be enough to stem the slide. In fact, a 25 bps hike was too timid and kept Indonesia behind the curve. In our view, the Central Bank should have increased the rate by 50 bps in its first action, to be followed by another 50 bps in order to beat the negative expectations.
Despite the recent volatility, the Indonesian economy is actually in good shape. The Central Board of Statistics just released the National Accounts Data, showing that in Q1 2018, the Indonesian economy grew by 5.06%. It is true that the rate of growth was slightly below the previous quarter. However, compared with the same period of 2017 and 2016, Q1 of this year was higher. Moreover, higher rates of investment growth as well as exports contributed to this quarter's GDP growth.
The growth of the economy was supported by an improvement in the balance of payments. Indonesia's current account improved slightly in Q1 2018 from the previous quarter. In Q4 2017, the current account registered a deficit of 2.34% of GDP, while in Q1 of 2018, it declined to 2.15% of GDP. Since the financial and capital account of the balance of payments recorded only a small surplus, the overall balance of payments reported a deficit of approximately $3.8 billion, leading the foreign exchange reserves of the Central Bank to fall to $126 billion at the end of March 2018. The FX reserves of Bank Indonesia declined further in April, to $124.8 billion.
The Central Board of Statistics also released the balance of trade data for April 2018. April is a critical month for the balance of trade because the month of Ramadan is less than one month away, while the Muslim festive holidays are just less than two months away. As in the past, imports jumped, by 11.28% to reach $16,095.1 million. This amount exceeded exports, which fell by 7.19% to reach $14,465.8 million. As a result, the trade balance reported a deficit of $1,629.3 million.
The Central Board of Statistics also released the inflation report, which showed relatively mild inflation for April at 0.10%. With that performance, year-over-year inflation stood at 3.41%, a level at the lower end of the target corridor of the Central Bank. However, even at that level of inflation, the Central Bank decided to raise the benchmark interest rate by 25 bps, to 4.50%, in order to reduce the level of volatility in the exchange rate against US dollar.
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