Doha: Bank Indonesia unexpectedly slashed its policy rate by 25 basis points to 7.5%. Inflation slowed from a peak of 8.4% in December 2014 to 7.0% in January 2015. The recent fall in oil prices more than offset the removal (in November and January) of large subsidies on petrol as well as cutting diesel subsidies to a small fixed amount (about USD0.08/litre).
It cited its efforts to reduce the current account deficit (currently 3% of GDP). Lower interest rates should weaken the exchange rate, boosting exports and making imports more expensive, helping to lower the current account deficit.
The bank has reversed its policy direction mainly as it expects inflation to fall. However, looser monetary policy may be negative for growth owing to the risk of capital flight and a potentially weaker exchange rate. High external debt in Indonesia means that a weaker exchange rate increases the debt servicing burden and could be a drag on growth.
From the 20 economists surveyed by Bloomberg, zero expected a cut in rates and the consensus forecast was very much for further tightening during 2015. BI was expected to tighten as inflation is above target, but also in order to counteract Federal Reserve (Fed) hikes in US interest rates, currently expected to start in mid-2015.
It gave two main reasons for the rate cut. First, in its press release the BI stated that it now expects inflation to fall to the lower end of its target range of 3% to 5% in 2015-16.
