Indonesia central bank unexpectedly cuts rate to 5.75pct

Indonesia's central bank unexpectedly cut its policy rate by 25 basis points to 5.75 per cent on Thursday ,after keeping it steady the past two months, in a bid to ensure that Southeast Asia's largest economy maintains strong growth.

The cut reinforces Bank Indonesia's position as one of the most dovish worldwide. It has loosened policy as insurance against weaker global growth even though there are concerns that inflation will rise this year in Indonesia.

Bank Indonesia cut rates 25 basis points (bps) in October and 50 bps in November, signalling it was worried about a possible repeat of the 2008 global downturn. But so far, the global picture has not been that grim and potential price pressures at home may force BI to walk a tightrope in designing its policy.

Indonesia achieved 6.5 per cent full-year growth last year, the highest since 1996, and inflation in January further slowed to an annual rate of 3.65 per cent, though analysts said planned government fuel price hikes and pouring rains could push up prices later this year.

Thursday's surprise cut "presumably really is a pre-emptive move to continue providing support for the economy, as the central bank has highlighted downside risks to growth and likely to revise its 2012 growth forecast very soon," said Gundy Cahyadi, an economist at OCBC Bank in Singapore.

"We question the need for this rate cut, as credit growth and M2 money supply growth have continued to be at high levels and inflationary risks remain in the picture," Cahyadi said.

Twelve out of 16 economists polled by Reuters expected BI to hold rates on Thursday. Some changed their view to hold from a rate cut after seeing strong 6.5 per cent growth in the last quarter of 2011, with robust investment and private consumption compensating for a slowing in export growth to single digits in November and December.

South Korea's central bank held its key policy interest rate steady at 3.25 per cent for an eighth consecutive month on Thursday, as it grapples persistently high inflation and weakening growth in Asia's fourth-largest economy.

In a Reuters quarterly poll conducted in January, economists had expected BI to cut the rate to 5.5 per cent by the end of this year before raising it by 50 bps in the first half of 2013. The economists forecast growth slowing to 6.1 per cent this year, below BI's estimate of 6.3-6.7 per cent.

BI in January lowered its deposit facility rate by 50 bps to provide extra liquidity to the banking system, which some analysts also saw as a form of policy easing.

The rupiah, which has strengthened more slowly than other emerging Asian currencies excluding China, may not help to damp imported inflation because it is one of the most volatile in the region.

The central bank still expects inflation to range between 3.5-5.5 per cent this year despite the government's plan to limit the use of subsidised fuels or hike pump prices that are the lowest in Asia.

"With this move, we believe the central bank capitalized on current positive real rates as inflation is trending close to 4.0 per cent. More so, inflationary pressures are clearly on the wane, provided the utility price hikes are deferred and fuel subsidies are left untouched," said Radhika Rao, economist at Forecast Pte Ltd in Singapore.

"However their optimism on growth and potential threats of renewed capital outflows leaves us a bit bewildered. This move might leave the rupiah more vulnerable amid potential capital flight, thereby requiring constant BI presence to minimise volatility in the domestic markets," Rao said.

Indonesia's good macroeconomic conditions have led Moody's and Fitch ratings agencies to restore its investment grade status, and Standard & Poor's may follow the move.

The country's government bonds have seen strong demand after the upgrade. Indonesia raised 50 per cent more than targeted in a February 7 auction, with yields falling and high demand especially for long tenors. Foreign investor ownership stood at 32 per cent as of February 7, compared with 30.8 per cent at the end of 2011.