FASBI Rate Hike Reflects Hard Times For Rupiah
BMI View: In line with our long-held expectations, Bank Indonesia (BI) hiked its deposit facility (FASBI) rate by 25 basis points (bps) on June 12. The move reflects the central bank's efforts to discourage heavy volatility in the rupiah, whose intraday trading range has soared over recent weeks. In combination with expected fuel price hikes later this month, we reiterate that BI is now likely to make a move on its benchmark interest rate over the coming months, with rupiah weakness effecting additional pressure on the central bank to hike sooner rather than later.
In a surprise move, Bank Indonesia (BI) hiked its overnight deposit facility (FASBI) interest rate by 25 basis points (bps) on June 12, taking it from 4.00% to 4.25%. While we have long expected BI to adjust the FASBI rate as a means to manage liquidity in lieu of hiking its benchmark rate, the central bank decided to hike the FASBI a day ahead of its scheduled monthly policy meeting, suggesting that volatility in the rupiah may have been the chief impetus.
|Pushing The Envelope|
|Indonesia - Exchange Rate, IDR/US$|
The currency has experienced increasing depreciatory pressures since late May, as a global EM sell-off and fears over Indonesia's poor external position have conspired to erode confidence in the unit. Intraday volatility has peaked as high as 3.6%, with indications that BI has been increasingly active on the open market in an attempt to defend the IDR10,000/US$ level. These indications have been reinforced by the performance of the central bank's foreign currency reserves in May, which fell by 2.0% in the month (notably, the bulk of the decline likely occurred in the last week of the month, during which time volatility ramped up considerably), and we expect June's reserves figures to reflect an even larger drawdown.
|Further Drawdown In Store?|
|Indonesia - Foreign Currency Reserves, US$bn|
Fundamental Pressures More Acute Than In The Past
While the rupiah has experienced similar periods of volatility in the recent past (September 2011, June 2012, and January-February of this year), we believe that its latest struggles are unique in the sense that fundamental pressures are now more acute. Despite the fact that its external position has stabilised somewhat following the major deterioration that began late in 2011, Indonesia continues to run a relatively wide current account deficit, and April's trade figures reflected a record monthly trade deficit of US$1.6bn. In addition, the country continues to be highly exposed by its poor net international investment position (a deficit equivalent to 36.7% of GDP in 2011), making Indonesian assets particularly vulnerable to even short bouts of portfolio outflows.
|Risk On The Rise|
|Indonesia - 5-Year Credit Default Swap, bps|
Informed by these risks, BMI opened a bullish Indonesian 5 -year credit default swap (CDS) position in December 2012 (reflecting our expectations for perceived risk in the country's assets to increase), and the instrument has since moved in our favour by 106bps. Moving forward, we continue to see potential for the CDS spread to widen further. Likewise, as a result of the rapid increase in volatility surrounding Indonesian assets, as well as policy-driven inflationary expectations related to the government's imminent fuel price hike, we reiterate that we believe BI will be forced to hike not only its FASBI rate but also its benchmark interest rate by a minimum of 25bps before the end of 2013.
Still Some Uncertainty Over Fuel Price Hikes
In fact, the recent performance of the rupiah suggests that a rate hike may be in the offing sooner rather than later, as the central bank's open market operations in support of the currency have proven insufficient to curb the erosion in confidence towards the unit. That being said, there is still some uncertainty surrounding the government's proposed implementation of fuel price hikes. Although multiple sources have stated that the hikes should take effect at some point in June following parliamentary approval of the revised state budget, coalition parties have once again begun to signal last minute trepidation, much as they did before a similar plan fell through in 2012. In our view, fuel price hikes are a necessary evil that will not only bolster the government's fiscal position, but also help to alleviate Indonesia's external position, while at the same time providing a much needed shot in the arm to investor confidence. However, while our base case scenario assumes that the government follows through with its promise on fuel price hikes, we note that there is at least a 25% probability that the deal falls through. In this case, BI may still be pressured to raise its benchmark rate in order to shore up confidence in the rupiah, but we would first expect to see more hikes to the FASBI rate.