Pretty much as predicted, the central bank (Bank Indonesia/B.I.) has on Thursday (July 18) lowered its 7-day reverse repo rate by 25bps to 5.75%, the first interest rate cut since September 2017, in an attempt to support growth amid low inflation expectations. The overnight deposit and lending facilities were also trimmed by the same amount to 5.00% and 6.50%, respectively.

Interestingly, composite index of Indonesia Stock Exchange (IDX) turned positive upon learing the rate cut in the last minutes of trading Thursday. Combined with political stability and policy initiatives, the rate cut paves the way for a stronger growth of investments.

Several central banks in advanced and developing economies have responded to the inauspicious economic dynamics by relaxing monetary policy, including the US Federal Reserve, which is expected to lower the federal funds rate (FFR). The prevailing policy response has reduced global financial market uncertainty and driven foreign capital inflows to developing economies.

Indonesia, meanwhile, has maintained relatively stable economic growth in the second quarter of 2019 compared with conditions in the previous period. Private consumption remains solid, backed by maintained consumer confidence. Furthermore, building investment continues to expand at a stable pace. Exports, however, are expected to contract on subdued global demand and lower commodity prices stemming from the ongoing trade dispute, although steel exports increased in June 2019.

The impact of simmering trade tensions on lower exports has been felt in a number of countries. In Indonesia, the export contraction has impeded imports and undermined nonbuilding investment. In general, B.I. projects national economic growth in Indonesia below the midpoint of the 5.0-5.4% range in 2019.

B.I. also noted that financial system stability has been maintained amidst a backdrop of adequate liquidity and lower credit risk. Solid bank resilience was confirmed by a high Capital Adequacy Ratio (CAR) of 22.3% in May 2019, coupled with a low level of non-performing loans (NPL) at 2.6% (gross) or 1.2% (nett).

The banking industry has also maintained adequate liquidity, as reflected by a ratio of liquid assets to deposits of 18.5% in May 2019, although it declined from 20.2% in April 2019. The intermediation function remains sound with the banking industry reporting credit growth in May 2019 at 11.1% (yoy), which is stable compared to the month earlier. On the other hand, the banks confirmed a moderate uptick in deposit growth to 6.7% in May 2019 from 6.6% in April 2019.

Bank efficiency also improved recently, as indicated by a low BOPO efficiency ratio recorded at a level of 81.71% in May 2019. In 2019, B.I. projects growth of outstanding loans disbursed by the banking industry in the 10-12% (yoy) range, with deposit growth expected in the 8-10% (yoy) range.

This B.I. benchmark rate cut will prompt banks to lower their lending rates and deposit rates, but it will take 1-3 months. The lower lending rates will reduce cost of borrowing, then this will benefit business sector.

The rate cut might not be welcomed by foreign investors, but they would move their funds into bonds and government’s treasury for ten years tenor as this investment instrument still offer attractive yield (7.1%), compared to US treasury’s 1.9-2% yield. No need to worry about the capital outflow.

Meanwhile B.I. also has room to cut the minimum statutory reserves (GWM), aiming for loosening the banking liquidity. B.I. expects to add banking liquidity by Rp25 trillion this year. This new policy was effective on July 1, 2019. The GWM ratio for conventional banks is set at 6% while syariah banks at 4.5%. This policy will boost the credit or lending, also third party funds. Per May 2019, banking’s loan to deposit ratio (LDR) reached 96%, supassing its maximum level of safety. The lower cost of funds would positively impact on net interest margin of banking industry. But concern over credit quality and trade war between US and China might undermine their bottomlines.

by Yohannes Obor

DISCLAIMER: NO POSITION IN STOCKS MENTIONED IN THIS ARTICLE