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Indonesia gets ready for Fed tapering

Richard A Brooks | AFP | Getty Images

Indonesia will do whatever it takes to prop up its battered currency and reassure investors that it can control a wide current-account deficit. This, say analysts, is the clear message from a surprise hike in interest rates.

On Tuesday, Bank Indonesia unexpectedly lifted its overnight lending rate by 25 basis points to 7.50 percent. It also increased the overnight deposit facility rate, known as the FASBI, by 25 basis points to 5.75 percent.

(Read more: Indonesia's central bank unexpectedly raises rates)

Since June the central bank has lifted rates by a hefty 175 basis points, taking the key rate to its highest level since 2009.

"It was the right thing to do," HSBC ASEAN Economist Su Sian Lim said in a research note, referring to Tuesday's rate rise.

"Significantly it is an affirmation that the central bank is well and truly aware that the current account deficit remains foremost in investors' minds, and that it is willing to do whatever it takes policy-wise to quell these concerns," she added.

Indonesia's current account deficit stood at $9.8 billion, or 4.4 percent of gross domestic product (GDP), in the second quarter. Data for the third quarter expected later on Wednesday and is expected show the current account deficit narrowed. The deficit is forecast at 3.7 percent of GDP for the third quarter, according to a Reuters poll of economists.

Indonesia, Southeast Asia's biggest economy, has been hit hard by fears of an unwinding of the U.S. monetary stimulus that has contributed to inflows of cash into emerging markets in recent years.

The country's wide-current account deficit has meant Indonesia has been punished more severely than some of its peers, with the Indonesian rupiah down some 20 percent against the U.S. dollar this year to become one of the world's worst performing currencies.

(Read more: Emerging markets get no love even as US bats up record highs)

The rupiah was trading at 11,630 per dollar on Wednesday, within sight of a six-week low hit on Tuesday.

"The hike can be interpreted as another signaling effect to shore up the rupiah and narrow the current account deficit," Cynthia Kalasopatan, market economist at Mizuho Corporate Bank, said in a note. She added that the move was also aimed at containing inflation. Indonesia's annual inflation was at 8.32 percent in October.

Pre-emptive?

Jitters about a scaling back of the Federal Reserve's monetary stimulus program have resurfaced following Friday's stronger-than-expected U.S. jobs data. Analysts say Tuesday's rate hike shows a determination by Bank Indonesia to take pre-emptive action before actual Fed tapering takes place.

(Read more: Emerging market reprieve is only temporary: Pimco)

"Bank Indonesia is often accused of being the behind the curve, but clearly [Tuesday's] move took economists and markets by surprise. It's a brave step but one which, in our view, is the right one to have taken," said Robert Prior-Wandesforde, director for non-Japan Asia Economics at Credit Suisse, in a note.

Mizuho's Kalasopatan said she saw the possibility of another 25 basis point hike in December or early next year. She added that the central bank was likely to pause after that to allow the economy to adjust.

—By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter

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