Bank Indonesia looking at tightening policy from late next year

Bank Indonesia has kept its benchmark interest rate at a record low 3.5 per cent since February. PHOTO: REUTERS

JAKARTA (BLOOMBERG) - Bank Indonesia could begin tightening monetary policy next year, including potential moves on interest rates, if the economic recovery remains on track and policymakers see signs of inflation.

The bank's exit strategy is to gradually reduce liquidity in the financial system "and then later, the end of next year, maybe some interest rate action", governor Perry Warjiyo told Bloomberg Television on Friday. "But this is very uncertain."

Bank Indonesia has kept its benchmark interest rate at a record low 3.5 per cent since February as a spike in Covid-19 cases overwhelms hospitals and oxygen supplies. The economy is still expected to expand 4.1 per cent to 5.1 per cent this year as early indicators, such as in the payment system, show no "significant decline" so far, even as the central bank is assessing the outlook, Mr Warjiyo said.

Growth is seen hitting 6.3 per cent and 5.5 per cent in the third and fourth quarters, respectively, he added.

The government recently downgraded its own forecast for the economy to 3.7 per cent to 4.5 per cent growth this year, from 4.5 per cent to 5.3 per cent previously after it reinstated stringent movement curbs over large parts of the country.

Rather than cutting rates further right now, Mr Warjiyo said the central bank would "maintain this low interest rate" and push banks to pass it on.

"What we're focusing on now, we're pushing the banks to follow suit," he said. "We're focusing more how to ensure the effectiveness or the transmission of our policy."

As rising poverty and unemployment amid the pandemic send Indonesia back to lower-middle income status, the government may need to risk a wider budget deficit to accommodate higher stimulus spending and delayed tax hikes.

The bank will closely watch how the pandemic impacts domestic consumption, the cornerstone of South-east Asia's largest economy.

For now, exports will continue driving economic growth thanks to the recovery in the United States and China, Warjiyo said.

The central bank is readying macroprudential measures, which could include fiscal incentives, to support small and medium-sized enterprises, as well as hotels and restaurants, he said. An earlier move to ease down payment requirements proved effective in prodding housing and car loans.

Malayan Banking foreign exchange strategist Yanxi Tan said: "With domestic Covid-19 trajectory weighing on the growth outlook, it might be prudent for Bank Indonesia to start dropping hints to the market on eventual monetary policy normalisation plans. At the very least, it helps to ease a key driver of market uncertainty."

Bank Indonesia's focus for the rest of the year is on keeping rates low and liquidity flush to support the economy, and maintaining a stable exchange rate, Mr Warjiyo said.

"We need to dance with the market, to ensure the stability of the exchange rate, the government bond yield, giving some room for adjustment but measurable, controllable and stable," he said.

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