Indonesian bonds plunge after Bank Indonesia keeps policy rate steady

The Indonesian government bonds plunged on Friday as Bank Indonesia (BI) left policy rate unchanged at 6.75 pct, as expected. The yield on the benchmark 10-year bonds, which moves inversely to its price, closed higher 0.26 pct to 7.443 pct and the yield on the 3-year bonds rose 0.30 pct to 7.252 pct by 0545 GMT.

Yesterday, the Bank Indonesia kept the reference rate on hold at 6.75 pct, on par with expectations, after lowering the rate three straight times in Q1 by 75bps. Bank Indonesia had kept the rates on hold for most part of last year. This was because of certain factors, such as deceleration in inflation to below 4 pct by late 2015 due to lower oil prices. The central bank projects inflation to be normal around 3-5 pct in 2016. Deceleration of inflation gave the way for the central bank to lower rates in the past few months.

Moreover, in an attempt to accelerate monetary policy transmission in the economy, the central bank announced plans last Friday to adopt 7-day reverse repo rate as the new benchmark policy rate from August 19th. The 7-day reverse repo rate, currently at 5.50 pct will replace the 12-month reference rate, which is currently at 6.75 pct to help spur lending and support growth. The central bank also said that it would narrow the interest rate corridor from 250 bps to 150 bps.

On the other hand, Indonesia recorded economic growth of 4.8% last year as is expected to continue to stay on a sound growth track, noted Scotiabank. Consumer spending supported by better consumer confidence and rising disposable income, primarily drives the economic activity. As the Indonesian government carries on with its attempts to start stalled infrastructure projects, increasing public outlays will provide stimulus to investment.

Recovery in the private sector investment in the following quarters will continue to be dependent on the existing progress regarding deregulation and improvement in the ease of doing business in the country, said Scotiabank. But lower commodity prices and weak external demand are expected to keep negatively impacting the country’s export sector, added Scotiabank.

“Indonesia’s real GDP gains are expected to average 5.2% y/y in 2016-17”, said Scotiabank.

“Indonesia will continue to record current account deficits through 2017, with the shortfall likely to expand slightly to 2.7% of GDP by 2017 from 2.1% last year”, added Scotiabank.

In addition, the March exports figure tumbled 14 pct y/y, against market expectation of 14.04 pct y/y, from 7.2 pct y/y decline in February. March Imports were also down 13.1 pct, against market consensus of 12.02 pct, as compared to 11.7 pct in February and oil and gas exports fell 38.2 pct y/y, from 36.5 pct y/y in February, indicating weak domestic demand and resulting in a trade surplus of USD 1.65bln. We expect the Bank Indonesia’s easing trend to continue in 2016 due to ongoing weakness in China and the Eurozone.

Meanwhile, the Bank Indonesia governor Martowardojo said recently that the central bank still has room to ease monetary policy, adding that Bank Indonesia would be data dependent albeit more cautious in future policy decisions.

Lastly, if exports, inflation and GDP growth fail to improve over the coming months, easing will occur sooner rather than later, pushing bonds prices further up.