Indonesia: BI Monetary Policy Meeting - BNPP

q BI holds policy rate steady at 6.75% in August.
q Key reason for the steady rate is that inflation remains under control in 2011.
q Credit growth remains well behaved, rising 24.2% y/y in August.
q Inflation target remains at 5±1% in 2011 and 4.5±1% in 2012.

Bank Indonesia’s decision to refrain from raising rates comes on the back of inflationary pressures which remains manageable and the fear of capital
inflows into the country, in our view. It is now unlikely for Bank Indonesia to raise rates this year given domestic credit growth remains well behaved (+24.2% y/y in August) and the fears of a downturn in the global economy in 2H11.

Like its Korean counterpart today, Bank Indonesia decided to keep its policy rate unchanged in August in line with consensus. Besides keeping its policy rate
unchanged, the central bank took the decision to widen the floor of its overnight interbank rate to 150bp from its current 100bp to ‘stimulate transactions in the
money market’. We see this as an attempt by the central bank to provide itself with greater flexibility to conduct its monetary policy operations in the midst of
excess liquidity. According to the central bank, foreign reserves in the country rose by another USD 2bn to a record USD 124.6bn in August.

This is the seventh consecutive month of Bank Indonesia keeping rates unchanged, a sharp contrast from the beginning of 2011 which saw economists debating whether the central bank was behind the curve as surging inflation and rising capital inflows
presented a policy dilemma for BI. Although inflation rose by a slightly faster pace of 4.8% y/y in August (up from 4.6% y/y in the previous month), the central
bank’s decision to keep its policy rate unchanged suggest that it views inflationary pressures under control and the August rise is due to temporary
factors. Indeed, the official view is that last month’s inflation was temporarily pushed up by strong festive demand for gold which will reverse out in September
this year.

In the August policy statement, the central bank warns of the impact of the global economic slowdown on domestic demand and the potential for more capital flows into emerging markets. Indonesia will not be immune from such trends, with the central bank forecasting continued capital inflows and IDR appreciation (due to the attractive yield of IDR assets) which will result in greater volatility. Indeed, the central bank has highlighted the need to be vigilant in the forex market in the August policy statement which was not the case in previous statements.

On the credit front, we continue to be encouraged by the latest credit growth figures. In Augut, they rose by 24.2% y/y which should be viewed as well behaved
especially given the low interest rate environment (see chart). According to the August statement, this is mainly to finance productive economic activities rather
than for consumption purposes.