Indonesia's Central Bank Raises Rates Amid Geopolitical Risks

Bank Indonesia, the country's central bank, astonished markets on Wednesday by raising its benchmark seven-day reverse repo rate by 25 basis points to 6.25%. The rate hike, the first of the year, comes as the central bank looks to support the tumbling rupiah currency and mitigate risks posed by geopolitical instability to Indonesia's financial markets.

The Indonesian rupiah has been under pressure, falling to a four-year low against the U.S. dollar due to rising global risk aversion and a delay in anticipated U.S. interest rate cuts. The rupiah is down about 5% against the dollar so far in 2024. Bank Indonesia Governor Perry Warjiyo justified the rate increase as necessary to bolster the rupiah's stability against worsening global risks.

Why this matters: The rate hike by Indonesia's central bank highlights the challenges faced by emerging market economies in navigating an uncertain global economic landscape. It emphasizes the potential impact of geopolitical tensions and shifts in U.S. monetary policy on the financial stability of developing nations.

Despite external headwinds, Bank Indonesia maintained its growth forecast for Indonesia's economy at 4.7-5.5% for 2024. However, annual inflation has climbed to a seven-month high, prompting the central bank's forward-looking policy to mitigate the domestic impact of rising global energy and food prices while keeping inflation within its target range of 1.5%-3.5% both this year and next.

Economists doubt the effectiveness of the modest 25-basis-point rate hike in steadying the rupiah, as the global backdrop remains volatile and concerns over Indonesia's growth outlook are mounting. Signs of tighter monetary policy and weak global demand are affecting economic activity. The central bank will likely be cautious about tightening policy too aggressively, as inflation is low and growth is struggling.

Beyond the interest rate hike, Bank Indonesia has also intervened more aggressively in the spot and derivatives markets to moderate sharp swings in the exchange rate. The government has ordered state-owned enterprises to refrain from making large dollar purchases and told exporters to repatriate their earnings.

Governor Perry Warjiyo expressed confidence that the rupiah will remain stable around 16,200 per U.S. dollar in the current quarter, strengthening to 16,000 in the next quarter and 15,800 by the fourth quarter. He also expects limited escalation of conflict in the Middle East, resulting in a moderate rise in energy prices.

The surprise rate hike by Bank Indonesia could establish the tone for other Asian emerging-market central banks facing similar currency pressures. "The rupiah has been languishing around four-year lows against the US dollar, down about 5% so far this year, due to a strong dollar and other global factors," Warjiyo stated, emphasizing the need for pre-emptive action to ensure inflation remains within target and to support the weakening currency amidst geopolitical instability posing risks to Indonesia's financial markets.

Key Takeaways

• Bank Indonesia raised its benchmark rate by 25 bps to 6.25% to support the tumbling rupiah.
• The rate hike aims to mitigate risks posed by geopolitical instability and global economic uncertainty.
• Indonesia maintained its 2024 GDP growth forecast at 4.7-5.5% despite rising inflation and global headwinds.
• Economists doubt the effectiveness of the modest rate hike in steadying the rupiah long-term.
• The surprise rate hike could set the tone for other Asian emerging-market central banks facing currency pressures.