Head, Treasury Research & Strategy
Member of OCBC Wealth Panel
Bank Indonesia (BI) slashed its policy rate last week, surprising some in the market though not us. The room given by low inflation and tame current account was too tempting, plus it’s either now or never given the year-end global event risks.
Thursday's move coincided with the second anniversary of Jokowi’s inauguration, and should help his government’s desire for higher lending growth – which is unhelpfully plumbing new lows now.
Still, rate cut cannot be a gift that BI can keep on giving. Dovish tone aside, we are much nearer to the end of the cycle by virtue of how much BI has eased already. One to two more cuts early next year if growth doesn’t pick up is possible, but that’s about it.
Watch what they watch
For a while now, it was apparent to us that BI was paying attention to loans growth data.
It played a key role in the spurt of easing movement by the central bank early this year, when it cut rates back-to-back for three months straight. It was probably one important consideration in its decision to tweak its monetary policy framework to adopt the 7-day reverse repo rate as its key benchmark rate too.
This time round, loans growth – or rather the lack of it, given that August’s 6.8 per cent yoy print is the lowest since 2009 – remains the key driver in the monetary policy decision. For good measure, its policy statement (as seen from the Bahasa version) notes that even as "transmission of monetary policy loosening is ongoing", "transmission through the credit channel remains not optimal, judging from the credit growth that remains limited."
For good measure, it ends the statement with this line: “Bank Indonesia is confident that the re-easing of monetary policy and the loosening of macro-prudential measures thus far would drive credit growth in order to support higher economic growth going forward.”
In its communication with the press post-decision, BI touched on how much its policy rate cuts have been passed through by the banks. Bloomberg, for instance, notes that BI mentioned that year-to-date, average deposit rate has declined by 108bps while lending rate dropped by 60bps. Notably, deposit rate has closely tracked the 125bps drop in policy rate year-to-date (prior to the latest decision to cut it down by a further 25bps, to a total of 150bps).
This is much more so than the contemporaneous drop in lending rate, of course, and would remain a point of contention that the authorities would have with the banking folks in Indonesia. For what it’s worth, BI told the press that it expects lending rate to drop by 15-20bps further by year-end.
In many ways, BI has been playing it smart by cutting its policy rate largely in instalments thus far. That helps to save its not-unlimited bullets over time. It has also been talking dovish talks. Even after slashing rates 6 out of 10 meetings already this year, it is still talking about how it “sees room to lower monetary policy”, albeit with a requisite caveat of “if data supports it.”
The whole game is to persuade the banks that “Hey guys, we are serious about cutting our policy rate, so why don’t you go ahead and ease yours already!”
While we think that lending rates could drop further, we cannot help but think that it will take a lot more than just policy rate easing carrots alone, whether those that are already on the plate or just merely dangled in front. As BI itself has repeatedly acknowledged, demand for credit – especially from the corporate side – has been dismal. If someone has little appetite, even if BI cooks up a storm and fills the room with the most enticingly aromatic dishes (with promises of more to come, to boot), he wouldn’t bite.
As to why there is so little appetite for credit to begin with, global uncertainties play a big role, and there’s not much the Indonesian authority can do on that front. The fact that newly enthusiastic taxpayers – individuals and corporates alike – had to fork out money in the last few months for tax penalty payments, as they participate in the successful tax amnesty programme, is another, thankfully one-off, factor.
Done for now
From BI’s end, what it can do would be increasingly limited.
Its heroic talks about having room to lower rate further might be true, given that inflation is low and current account deficit is less concerning now, but it is also a reality that there is going to be less space for them to manoeuvre going ahead.
Given where oil price might be heading, it needs to build in potential of an inflation uptick next year. The Fed’s move up on its policy rate would also become a consideration. Hence, we think BI is done with rate easing this year, opting to leave the increasingly limited space for next year, just in case its help might be needed again.
Our investment views for the week:
- The effects of monetary easing in the form of QE and negative interest rates are diminishing and near its limits.
- Central banks are recognising that negative interest rate policies need to be calibrated more carefully, so the harm to the financial sector does not neuter the impact from lower borrowing costs.
- Given the near exhaustion of monetary options, aversion to fiscal stimulus is now fading. While developed economies face weak government finances, in a world of very low interest rates they still have some policy flexibility.
- There’s little by way of market catalysts at this point. Equities will likely trade within a range but with higher volatility. Investors should look to pare down their exposure to developed market equities like U.S., Europe and Japan, and pivot to Asia Ex-Japan where outlook and recent performance has been solid.
- With long term government bond yields anchored at record lows, the hunt for yield will continue and high yield bonds may continue to see more inflows. However, the risk-on environment underscores the need for caution as we have seen the spike in bond issuance from low quality issuers. Investors need to be circumspect and selective when taking exposure to these investments even while we remain positive on high yield bonds.
- Ultimately, the hunt for yield should be accompanied by the search for quality in the context of a diversified portfolio. This should go far to create a stable portfolio.
- We remain Neutral Cash, and maintain our views on the bond sector: Positive EM IG, EM HY and DM IG. We maintain our negative stance on U.S. HY.
- We retain our Negative stance on Equities amid valuation concerns with preference for income rather than growth. From a regional perspective, we are negative DMs (U.S., Europe and Japan), while Neutral on Asia Ex-Japan.
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