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Indonesia on central bank-watch: To cut or not to cut?

The Bank Indonesia building stands in Bandung city, West Java, Indonesia.
Dimas Ardian | Bloomberg via Getty Images
The Bank Indonesia building stands in Bandung city, West Java, Indonesia.

A decline in inflation to a one-year low and economic growth trailing estimates would typically spur Indonesia's central bank to cut interest rates. Analysts seem less sure.

According to a Reuters poll, 12 out of 13 economists surveyed think that Bank Indonesia (BI) lack room to ease policy and will hold its benchmark rate at 7.50 percent, where it has been since February. The policy decision is due at 4pm local time.

Even though Indonesia's inflation rate dropped to its lowest in nearly a year last month, analysts note that policymakers will likely hold the line on interest rates due to concerns about the rupiah and to discourage capital outflows ahead of a rate hike by the Federal Reserve.

The annual inflation rate slowed more than expected in October, with the consumer price index (CPI) rising 6.25 percent on-year, down from September's 6.83 percent gain. The October rate is the lowest since November 2014, when President Joko Widodo raised subsidized fuel prices by more than 30 percent.

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It is widely assumed that a rise in U.S. interest rates for the first time in nearly a decade will spur investors to yank money out of emerging markets such as Indonesia as safer U.S. assets become more attractive.

"The outlook for the rupiah remains the crux of the matter. BI is no longer tolerant of a weak rupiah… which has been a drag on overall investment growth. At the same time, a weak rupiah is unlikely to boost export growth, given that Indonesia is still heavily reliant on commodity exports," a note from DBS Group Research said on Tuesday. "Given the uncertainties with regards to the U.S. rate hike, avoiding a rate cut at this juncture is presumably the safe choice."

In addition, holding off a rate cut would help contain Indonesia's current-account deficit, which was nearly 3 percent of gross domestic product (GDP) in 2014 but has since narrowed to 2 percent of GDP this year.

"Caution should prevail on the outlook of Indonesia's external balances next year. While [current account] deficit has narrowed this year, expect it to widen again in 2016 if there is a significant recovery in investment growth. External financing risks may haunt the domestic markets once again next year," DBS analysts added.

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Meanwhile, recent comments from BI Governor Agus Martowardojo suggest that the central bank is unlikely to succumb to the chorus of calls for easing in the country. Indonesian business associations and government officials such as the country's chief economic minister, have repeatedly called for a rate cut to stimulate the economy. [103136485]

According to an article by Indonesia's largest English broadsheet, The Jakarta Post, on November 10, Governor Martowardojo said the central bank will continue to focus on stability over growth policy and a rate cut in the near term was unlikely.

While noting that the monetary review will be a close call, Barclays analysts Wai Ho Leong and Angela Hsieh expect BI to announce a 25-basis-point rate cut this month due to the "rolling down of the inflation trajectory, coupled with better external balance."

Tim Condon, head of research for Asia at ING Financial Markets, is also among the minority calling for a rate cut. "We think the main constraints on BI easing - high inflation and a wide current account deficit - have lifted and we forecast a 25-basis-point policy rate cut either tomorrow or at the December 17 meeting."

Southeast Asia's largest economy expanded 4.73 percent in the three months to September, narrowly missing analyst expectations of 4.79 percent but higher than second quarter's 4.67 percent which marked the weakest pace of growth since 2009.