CLSA Indo Economics

Indonesia exchange rate – 9000 barrier smashed
The rupiah easily broke through the IDR9,000/USD barrier today and is trading close to our 8,950 end- 2010 target. We had correctly argued that it would be impossible for Bank Indonesia to resist a break through 9,000 given the massive net capital inflows.

Bank Indonesia has probably also decided to use appreciation as a monetary policy tool for curbing inflation. Official expectations are for a 1% MoM rise in July inflation (following the electricity price hike) which will lift the annual rate to 5.6% YoY (a doubling of inflation since the end of last year).

While the inflation spike from the electricity price hike will arguably be a one off effect, inflation pressures could be fueled by accommodative monetary conditions (with M2 money supply growing at 15% QoQ annualised in May).

We maintain our forecast for a 75bp increase in interest rates by end-March 2011.
The banks may increase their lending rates by less than this though, yielding to pressure from Bank Indonesia to advertise their prime lending rates and step up
lending. Reserve requirements will be increased for banks that do not exceed a 75% loan to deposit ratio.