Bank Indonesia (BI) is expected to hike its benchmark interest rate by 25 basis points to 5.00 percent by the third quarter of this year, following hopes of a strong growth in the country’s gross domestic product (GDP). Also, inflation has bottomed and is on a rising trend.

Recent data have been rather encouraging for the GDP growth outlook. For example, January trade data reaffirmed that export and import growth bottomed last year. Imports expanded 14.5 percent y/y in January, its highest growth since May 2012.

Apart from the 48 percent jump in oil imports, non-oil import growth was also strong at 10.1 percent. On a positive note, the recovery in demand of capital goods was partly responsible for the lift in import growth. Imports of capital goods were up 6 percent y/y in January, a nice change after four years of contraction. More importantly, this reflected stronger investment-related demand this year.

"We reckon that a 25bps rate hike is still likely later this year. Real GDP growth may accelerate to 5.3 percent this year from 5 percent in 2016, into the upper half of BI’s 5-5.4 percent target range. The upward trend in inflation is intact. Maintaining rupiah stability will be a priority this year because of rising US interest rates," DBS Group research commented in its latest publication.

The central bank has been building up its foreign reserves and will continue to do so this year. The USD 10 billion worth of foreign reserves accumulated in 2016 was equivalent to the total net foreign inflows seen in equities and IDgov bonds for the year. Reserves rose further to USD 116.9 billion in January, and currently provide about 9x of monthly imports and 2.6x of short-term external debt.

"We are encouraged that, in spite of the high base in 4Q15, investment growth was decent at 4.8 percent in 4Q16. Hence, we expect investment growth to improve to 5-5.5 percent this year from 4.5 percent last year," the note added.

Lastly, the BI is closely monitoring the US Federal Reserve rate trajectory and its potential impact on financial markets. A move by the Fed in March and indications of more hikes to come are likely to prompt BI to start normalizing as well, given supportive growth-inflation dynamics.