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Indonesia current account gap widens, key rate held steady

Indonesia's central bank on Thursday reported a larger than expected second quarter current account deficit, but kept its key policy rates unchanged, and predicted improvement later this year.

Bank Indonesia (BI) Governor Agus Martowardojo said the benchmark rate - in place since November - is consistent with the its 3.5-5.5 percent inflation target and with lowering the current account gap "towards a healthier level".

A year ago this time, the rupiah was dropping sharply, in large part because of market worry about the size of Indonesia's current account deficit.

Read MoreDays of 6-7% growth look distant for Indonesia

The central bank also left unchanged the deposit facility rate, or FASBI, and the lending facility rate at 5.75 percent and 7.50 percent, respectively.

High rise residential and commercial buildings stand in Jakarta, Indonesia.
Dimas Ardian | Bloomberg | Getty Images
High rise residential and commercial buildings stand in Jakarta, Indonesia.

All analysts in a Reuters poll predicted BI would keep its key rate at 7.50 percent even though growth has fallen to its slowest since 2009 and inflation has eased, to help rein in the current account deficit.

Also on Thursday, Finance Minister Chatib Basri said the slowing of growth was by design as "the strategy is to choose stability over growth".

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The current account is the widest measure of the flow of goods, services and money in and out of a country.

Martowardojo said the April-June deficit was 4.27 percent of gross domestic product (GDP), or more than double the first quarter's 2.06 percent. A Reuters poll had expected a second quarter gap of 4.0 percent, while the gap in the same period of 2013 was 4.4 percent of GDP.

Better number ahead?

The governor said the current account is "predicted to get better ahead" as big mining firms who had to stop exports of mineral ores had renegotiated contracts and shipments are resuming.

He expected current account deficit to reach $27 billion, compared to $29 billion in 2013. He didn't express the deficit as a percentage of GDP. BI's target has been a deficit this year of around 3.0 percent, compared with 3.3 percent in 2013.

Juniman, an economist with Bank Internasional Indonesia, said the most effective way to lower the deficit would be to cut oil imports by raising domestic oil prices.

Read MoreIndonesia has no room for economic nationalism: Fin Min

But he said that President Susilo Bambang Yudhoyono, whose tenure ends in October, "will avoid making that decision. President-elect Joko Widodo will probably not raise the price this year because he'll have his honeymoon period in the first three months."

In mid-2013, as the current account deficit topped 4 percent, inflation neared 10 percent and the rupiah tumbled, BI tightened monetary policy.

Between June and November - when the benchmark rate was last changed - it raised interest rates 175 basis points to 7.50 percent.

Read MoreWhat Indonesia really needs to kick-start growth

The rupiah, which weakened more than 21 percent in 2013, has strengthened more than 4 percent this year. The election of Widodo as president has helped bolster the currency.

A brake on growth

After the announcement on the second quarter's current account deficit, the rupiah pared some of its gains for the day and was at 11,680 to the dollar. It had ended Wednesday at 11,690.

The central bank's past rate hikes have put a brake on inflation and economic growth.

GDP growth had slowed to the weakest pace since late 2009 at 5.12 percent in the second quarter of this year and annual inflation had dropped to 4.53 percent in July.

Read MoreIndonesia stocks surge to 1-year high post election

Economists agree monetary policy will remain tight for the rest of the year, if not get tighter given the risk that The U.S. Federal Reserve, which is steadily cutting its quantitative easing, moves sooner than expected to raise interest rates.

At present, there's record foreign ownership of Indonesian government bonds, but higher interest rates in the U.S. could cause outflows from them.

Most analysts in a Reuters poll expected BI to keep the benchmark interest rate steady until end of 2014, but two saw a rise of 25 basis points to 7.75 percent before January.

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