IDR: Should the BI Continue To Defend?
Perry Warjiyo is resolute in defending the IDR, but for how long?
18 Dec 24 marked a significant day for monetary policy events. Bank Indonesia (BI) continued to hold rates while the US Fed cut later that day. However, the US Fed cut was less market-moving than the Summary of Economic Projections. US Fed governor dialed back the 2025 median rate cut forecast from 4 cuts to 2 with inflation projected to end 2025 at 2.5%.
Hawkish repricing of the USD sent the IDR downwards as higher for longer rates gave investors confidence in a strong USD with short-tenor UST expected to stay higher for longer.
BI now faces a dilemma: despite widening policy rate differentials—the main source of recent IDR strength—the IDR has surpassed the critical USDIDR 16,000 level Telok Ayer Macro argues that Perry Warjiyo is facing an increasingly constrained ability to manage the IDR.
Firstly, BI’s rates-driven FX strategy is increasingly complicated as its intervention in the SRBI and IndoGB markets is now in conflict. Secondly, Perry Wajiyo’s focus on keeping USDIDR below 16,000 will squeeze the real economy as it artificially keeps the IDR strong against its Asian crosses.
Historically, Rates Differentials Have Supported the IDR
In the past 2 years, we have seen a strong correlation between the strength of the IDR and the yield differentials between 10y UST and 10y IndoGB. Much of this differential stems from the BI Rate being held much higher than the Fed Fund Rate, ensuring that IndoGBs remain an attractive asset when foreign investors look for exposure to High Yield bonds.
Prior to the events of 18 Dec 24, the USDIDR flirted with >16,000 levels once in Oct 23 and successfully broke that level in Apr 24. In both cases, BI intervened by unexpectedly raising the BI Rate by 25bps during its Oct 2023 and May 24 meetings
This showcases 2 things. First, BI has an extremely strong desire to keep USDIDR below 16,000 and they would opt to hike even when inflation has settled down to support the IDR. Second, rate hikes are the preferred form of intervention, BI wields it like a sledgehammer and will move without preparing the market.
These factors make the most recent USDIDR move above 16,000 interesting. The BI’s ability to surprise markets and hike rates is extremely constrained. As the global monetary easing cycle continues, further tightening rates to support the IDR will surely limit the competitiveness of domestic firms in the global market. The large, export-reliant commodity sector will be under some pressure if the BI moves against the wind. Especially since inflation has long been conquered, BI hikes may be a harder proposal to pitch to stakeholders.
Perhaps, this time BI will have to opt for new intervention avenues.
Buy High, Sell Low: BI Bond Market Intervention
BI is in a challenging position, likely lowering onshore yields via its 'burden-sharing agreement' while increasing yields for foreign investors through the SRBI. This approach essentially results in financial losses by purchasing low-yield bonds while issuing higher-yielding securities
BI Intervention in Government Bonds
Grace Sihombing & Prima Wirayani recently reported that BI will purchase IDR150tn worth of government bonds to offset the IDR100tn maturing bonds in 2025. This is part of the “Burden-Sharing Agreement” where BI bought IDR800tn worth of bonds from 2020 to 2022 to help fund pandemic-era policies.
The additional IDR50tn government bond purchases signal to the market that this is not a routine rolling over of bond holdings. Investors are now suspicious of a “hidden yield curve control” where BI seeks to cap yields to encourage private borrowing.
TAM is unsure of how long more can this policy last. BI has been reported to already hold more than 25% of existing tradable government bonds and the IDR150tn planned purchase represents 1/4 of total government bond issuance in 2025. The path towards BI unwinding its pandemic-era bond holdings is now increasingly less clear and concerningly, future market interventions will be increasingly difficult to pull off.
SRBI Waning Effectiveness
On the other hand, the BI has been issuing SRBIs, a high-yielding bond issued to attract FX inflow to support the IDR. Using the government bonds that it holds as collateral, BI has used SRBIs to provide a quasi-government bond for foreign investors to park their money in. This allows BI to raise yields without hiking the BI Rate and further widen the ID-US yield differentials which is hoped to support the IDR
Despite SRBI yields being firmly above 7% for the past year (barring a dip in Sep 24), foreign investor interest in the security has tapered off with overall SRBI holdings by non-residents slightly falling from IDR250tn in Aug 24 to IDR243tn in Nov 24. Domestic banks and residents have been the main source of demand in recent auctions, so the SRBI has not been able to attract FX flows to support the IDR in recent months.
Of course, this is not entirely due to the BI, EM assets have been remarkably unattractive in the recent dollar-positive environment. Coupled with the general preference for foreign investors to enter Indonesian markets without FX hedges, we see that US-led volatility and the carry-trade unwinding have caused the SRBI to be an increasingly unattractive option.
When taken together with the recent announcement of BI’s expansion of government bond purchases, it seems that the Cenbank is buying low-yielding bonds to use as collateral for issuing high-yielding SRBI that have been mostly benefitting domestic investors and not supporting the IDR. A situation that is complicated when you consider that increased holdings of SRBI by domestic investors crowd out the demand for onshore bonds. This would raise BI’s market share of government bonds past 25%, further constricting policy space.
IDR Is Strong vs Peers
The prevailing narrative from both the media and BI themselves is that the USDIDR has to be kept below 16,000 to prevent an excessively weak IDR. However, when compared to its trading partners, the IDR is actually strong and is richly valued.
In 2024, the Indonesian Real Effective Exchange Rate (REER) has been remarkably strong and has kept itself above the 100 mark for 7 out of 11 months thus far. While the BI has been focusing on supporting the IDR, many have failed to recognise that the IDR has been persistently strong outside of the USD. A situation that actively reduces Indonesian price competitiveness and remains an additional drag on growth drivers.
The USDIDR has been weaker than the cross rates of Indonesia’s largest trading partners, indicating that the struggle to keep the USDIDR above the 16,000 level is largely due to a strong USD rather than a weak IDR. Further attempts to support the USDIDR risk pushing IDR much stronger against its other trading partners. This could result in domestic exporters losing competitiveness internationally, while increased consumption of imported products could crowd out local producers.
A key risk here is clear, Trump’s policies have thus far been overwhelmingly dollar-positive. A dogmatic approach from the BI in supporting the USDIDR pair will cause the IDR to be overvalued against its Asian peers and be a drag on Indonesian growth prospects. The CNYIDR pair in particular is the cross to watch as the prospects of a tariff may push the CNY weaker, which will concern Indonesian producers since China remains its largest export market.
Since inflation has been securely within the BI target range, neither domestic consumers nor producers truly benefit from the continued support of the USDIDR. It might be detrimental to both segments as an artificially strong IDR reduces the viability of Indonesian products while consumers do not benefit from increased price stability.
Conclusion
BI to remain hawkish, perhaps regrettably so. The consensus thus far is for BI Rate to end at 5.25% in 2025, largely due to the expectation that BI will prioritize IDR strength over all other considerations. TAM expects 1 cut in 1Q25 with another in 2Q25. further cuts are questionable and depend on the USD.
However, continued BI interventions in the bond and FX markets appear increasingly distortionary. The benefits of these interventions are diminishing, and this strategy may soon become unsustainable for BI. We recommend observers to keep an eye on the Indonesian reserve position, and foreign demand for the SRBI, and USDIDR/IndoGB market developments to guide their understanding of future BI Rate decisions.