Indonesia Central Bank Raises Rates in Unexpected Move to Support Rupiah

Indonesia's central bank, Bank Indonesia (BI), unexpectedly raised its key interest rate by 25 basis points to 6.25% on Wednesday, marking the first rate hike of the year. The move defied broad projections for a hold as the central bank looks to bolster the declining rupiah currency amid global risk aversion and a delay in expected U.S. policy easing.

BI Governor Perry Warjiyo stated that the rate hike is aimed at "strengthening the stability of the rupiah exchange rate amid the risk of a worsening global economy." The rupiah extended gains after the announcement, rising 0.45% against the dollar. The currency has fallen to around 16,200 per dollar, the weakest since 2020, due to risk-off sentiment in markets.

The central bank also raised the overnight deposit facility and lending facility rates by the same amount. BI expects the rupiah to remain stable around 16,200 per U.S. dollar in the current quarter, strengthen to 16,000 in the next quarter, and reach 15,800 by the fourth quarter of 2023. The rate hike is expected to narrow yield differentials, strengthen Indonesia's financial account, and anchor the under-pressure rupiah.

Why this matters: Indonesia's unexpected rate hike highlights the growing challenges faced by emerging market economies in navigating the shifting global financial landscape. The move underscores the importance of maintaining currency stability and mitigating the impact of external risks on domestic economic conditions.

Despite the external headwinds, BI expressed confidence in Indonesia's economic resilience, maintaining its 2024 growth forecast at 4.7-5.5%. However, the central bank acknowledged concerns about rising global energy and food prices and their impact on domestic inflation, which climbed to a seven-month high in March. BI's policy aims to mitigate the domestic impact of these global factors while keeping inflation within its target range.

Governor Warjiyo emphasized that the rate hike is a pre-emptive and forward-looking step to ensure inflation remains within the target. He stated, "Global economic and financial dynamics are rapidly changing due to increasing risks and uncertainties stemming from changes in US monetary policy and intensifying geopolitical tensions in the Middle East, leading to capital outflows and further depreciation of currencies in emerging markets."

Key Takeaways

• Indonesia's central bank unexpectedly raised key rate by 25 bps to 6.25%.
• Rate hike aims to bolster declining rupiah amid global risk aversion and U.S. policy.
• BI expects rupiah to strengthen to 16,000 per USD in Q2 2023 and 15,800 by Q4.
• Rate hike to narrow yield differentials, strengthen financial account, and anchor rupiah.
• BI maintains 2024 growth forecast at 4.7-5.5% despite global economic and financial risks.