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Indonesia raises interest rates to support sliding rupiah

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Indonesia’s central bank has unexpectedly raised its benchmark interest rate in a bid to support the sliding rupiah, which is trading near four-year lows as currencies across Asia come under pressure from a strong dollar and expectations of a delay in US rate cuts.

Bank Indonesia on Wednesday raised its seven-day reverse repo rate 0.25 percentage points to 6.25 per cent, the highest since the bank adopted the instrument as its benchmark rate in 2016. Most economists polled by Bloomberg had expected the central bank to hold rates.

The rupiah has shed nearly 5 per cent of its value against the dollar this year as the rising dollar has dented emerging market currencies in the region. 

The rate rise was intended to strengthen the rupiah in response to “worsening global risks” and represented a “pre-emptive and forward looking” step to ensure inflation remains within the central bank’s target range of 1.5 to 3.5 per cent, Bank Indonesia governor Perry Warjiyo said in a briefing. Indonesia’s inflation rate rose to 3.05 per cent in March year on year, the fastest rate since August.

Warjiyo added that a “strong policy response” was needed due to rising uncertainties around the US Federal Reserve’s rate outlook and escalating tensions in the Middle East.

The rupiah strengthened 0.4 per cent against the dollar to 16,155 on Wednesday.

Line chart of $/rupiah spot rate showing Indonesia’s rupiah is down 5% against the dollar this year

The rate rise move came amid growing market expectations that the Fed will delay expected rate cuts this year in response to higher US inflation and resilient economic performance.

The Indonesian central bank intervened in foreign exchange markets last week to support the rupiah after the currency crossed the 16,000 mark against the dollar. The government also asked state-owned companies to refrain from purchasing the dollar in large amounts. 

Other central banks in the region have signalled that they were prepared to take action. The Bank of Japan said last week that it could raise interest rates if the impact of a weakened yen became “too big to ignore”, while policymakers in China and South Korea have expressed concerns about the dollar’s strength.

The rupiah has also taken a hit from concerns that president-elect Prabowo Subianto’s populist policies could endanger Indonesia’s fiscal deficit targets. Prabowo, who will take over from outgoing president Joko Widodo in October, has promised a free meals and milk programme for schoolchildren that is expected to cost Rp460tn ($28.5bn).

The rate increase “underscores their long standing focus to support the rupiah stability”, said Christopher Wong, foreign exchange strategist at OCBC.

Capital Economics’ senior Asia economist Gareth Leather said Indonesia, which also unexpectedly raised rates last October to support the rupiah, was unlikely to raise rates further.

“With inflation very low and growth struggling, the central bank will be wary about tightening policy too aggressively and we doubt today’s hike marks the start of a prolonged hiking cycle,” Leather wrote in a note.

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