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- Interested in Interest Rate
What's going on?
Bank Indonesia (BI) decides to hold key interest rate steady at 3.5%.
What does this mean?
As Indonesia's central bank, BI has two key objectives: (1) maintain stable price, and (2) keep unemployment low by boosting economic growth. There are a few levers that they can use to achieve this. The most powerful of which is the central bank interest rate (also called the BI 7-day reverse repo rate).
A quick primer on interest rate:
When the economy is slow and unemployment is too high, central bank would lower interest rate. Lower rate incentivizes businesses to borrow more money at cheaper cost and invest in more projects, generating more jobs, and boosting the economy.
On the other hand, when the economy is too hot and inflation is uncomfortably high, raising the interest rate would have the opposite effect. Businesses becomes less likely to borrow money, leading to less investments and less spending. A slowdown in economy ensues, which brings inflation back down.
This act of adjusting the interest rate up and down to control the economy is called monetary policy.
Source: Me drawing on my phone 😎
Ok, lesson over. Back to the story...
Central banks around the world have been increasing interest rates in response to soaring inflation this year. The US Fed have raised interest rate from 0.08% at the start of the year to 1.21% now, with more hikes expected this year. Meanwhile the European Central Bank (ECB) just announced its first rate hike since 2011 in a few days time.
So why does BI decides to keep the interest rate steady?
A few reasons.
One, while the effect of inflation is definitely felt here (anyone bought red chilli lately? 🌶️🌶️ ), the core inflation level in Indonesia is relatively lower compared to other countries. Our core inflation is at 2.63%. US core inflation is more than double at 5.92% and the UK reached its peak at 6.2% in April.
And two, keeping rates low would make the Rupiah weaker compared to the US dollar. Wait a minute, isn't that bad? Well, yes and no. A weaker Rupiah means imported product becomes more expensive. On the flip side, Indonesian products become cheaper in the eyes of international buyers. This would have the positive effect of increasing the competitiveness of local products and boosting exports (which means more jobs to go around for making those products).
Why should we care?
This looks to be a strategic play by our central bank. With inflation seemingly under control compared to other countries, keeping rates steady would strengthen export competitiveness and create more jobs as we continue our recovery from the pandemic, especially in export-intensive manufacturing sector. However, this comes with the risk of making our financial assets less desirable to investors. Is this a risk worth taking? Only time will tell.
Until next time...
- Jason
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