It's taken from The Jakarta Post, September 16th, 2010
Bank Indonesia has recently announced that it would raise the primary reserve requirement (GWM) from 5 to 8 percent starting from the beginning of November.
In our view, this is on the heels of continued strong economic upswing with August inflation of 6.4 percent year-on-year, already above the central bank’s target ceiling of 6 percent caused by higher food prices, which have climbed during the Ramadan fasting month, exacerbated by longer than usual rainy season that has disrupted crop harvests.
Going forward, there may be further pass-through from July’s electricity tariff hike while more administrative price hikes could also be in the pipeline in 2011.
Therefore, based on our conversation with BI, the central bank will continue to remain watchful of continued inflationary pressure ahead, particularly given that indicators of domestic demand remain buoyant. August motorcycle sales were up 4.3 percent month-on-month and 23.1 percent year-on-year while car purchases were up nearly 35 percent year-on-year.
Weaker external conditions will have some impact on Indonesia, but not sufficient to derail our 6 percent GDP growth target for the full-year.
In this regard, BI is implementing higher reserve requirement to mop up excess liquidity. This, coupled with a reference to the acceleration in core inflation in BI’s recent monetary policy statement, suggest that the Indonesian central bank has shifted to a tightening bias.
We fully concur with BI that this is the right step to take, particularly since raising reserve requirement does not attract more short-term speculative capital inflows.
Increasing the reserve requirement is also consistent with the target of lifting the banking system’s loans to deposits ratio (LDR) to 78 to 100 percent target range by March 2011.
However, with demand side inflation pressures rising, it is possible in our view that BI could also be forced to hike the reference rate soon to ensure that inflation quickly returns to the 4 to 6 percent target range.
On the rupiah front, the currency has remained relatively flat against the US dollar at around Rp 8,975 per US$1 at present compared to the beginning of August at around Rp 8,940, although capital inflows have been strong.
Thus, even in the context of a sharp drop in the external surplus and the likelihood that portfolio capital inflows will peak out soon, we expect continued strong GDP growth and more favorable interest rate differentials to keep the rupiah at relatively stable levels.
We forecast the rupiah to end the year at Rp 9,100.
Additionally, we expect that the rupiah will gain to the Rp 9,000 level in 2011, reflecting a far more modest gain next year, although we believe that fluctuations could be much more severe ahead on volatility of funds flows.
Nevertheless, Indonesia’s prospect of achieving investment grade in the first semester of 2011 and support from investors looking for higher rates, will provide support for government bonds in our view.
However, sustained BI policy tightening, with the benchmark rate to reach 8 percent (+150bps from current levels) by end of 2011, should translate to higher yields in the next 12 months.
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