Jakarta: Indonesia’s central bank unexpectedly cut its benchmark policy rate on Tuesday, the first such move by a G20 member after Brazil, as Jakarta seeks to stimulate domestic demand and maintain investor confidence in Southeast Asia’s biggest economy.

Despite few signs of actual cooling in a hot Indonesian consumer market, Bank Indonesia cut the rate by 25 basis points to a record low 6.50%, underscoring growing concern among policymakers that a global recession may be coming.

Darmin Nasution, governor of Bank Indonesia, speaks during a news conference at the central bank in Jakarta, Indonesia, 11 Oct 2011 (Bloomberg)

“So far, the impact of the global economic turmoil is more felt in the financial markets, while the real sector is not yet impacted. However, a weakening global economy is estimated to impact the domestic economy in 2012," said Bank Indonesia in Tuesday’s policy statement, adding this would lead it to pursue interest rate and other monetary policy responses.

“We are bringing the policy rate to a level that is more reasonable," Governor Darmin Nasution told reporters. “We saw the 6.75% rate as too high, unless we estimated inflation next year to be very high."

Just a month ago, many analysts expected Bank Indonesia - which only raised rate once this year, in February - to hike them once more by end-2011 to curb inflation. But then, as turmoil wracked financial markets while inflation eased, , central bank officials started talking about having “room" to cut rates.

So Bank Indonesia was seen as being among the first Asian central banks that would loosen policy. Still, a cut as early as now was not expected. In a Reuters poll last week, all 11 analysts forecast that BI would leave the rate at 6.75% on Tuesday, though three of the 11 forecast a cut to 6.50% by the year-end.

In September, annual inflation slowed to 4.61% due to easing food prices, and the central bank now sees it below 5% next year too, well within its policy target range.

As global funds saw Europe’s debt crisis intensify, they pulled money out of Indonesian stocks and bonds, reinforcing Bank Indonesia’s worries about the country’s exposure to foreign funds and leading policymakers to keep asserting that the economy’s domestic fundamentals are in good shape.

Indeed, industry data on Tuesday showed car sales in September surged 62% from a year earlier, while motorbike sales jumped 51%. Toyota last month announced plans for $337 million of investment in the country.

Yet foreign portfolio investors, who held 35.7% of total Indonesian government bonds in early September, dumped 37.13 trillion rupiah by 5 Oct reducing their ownership to 30.7%.

Tuesday’s rate cut led the yield on benchmark 10-year Indonesian government bonds to edge lower to 6.4% on investor buying, from 6.5% before the central bank meeting.

Intervening heavily

BI has more than doubled its foreign reserves since 2008 and intervened heavily in the past month to prop up the rupiah, causing the reserves to fall to $114.5 billion as of 30 Sept from $124.6 billion a month earlier.

Still, the rupiah has slid 5% since the end of August, undermining BI’s efforts to use a stronger currency to temper imported inflation and leaving reserves likely to fall further as Nasution said BI will continue guarding the rupiah.

“This is a brave decision. Two thumbs up. This is not expected by the market and it shows that Bank Indonesia is over confident with the currency. In the short term, the rupiah will depreciate...Bank Indonesia will need to do more intervention," said Juniman, economist at BII in Jakarta.

“Inflation is below 5%, that’s why they cut the rate...In the medium and long term, the decision will give stimulus to domestic demand."

The rupiah was little changed after the rate decision, having earlier fallen about 0.6% against the dollar. Indonesian stocks also showed little initial reaction to the rate move, holding on to gains of more than 2% earlier in the session, buoyed by global markets.

“ The key will be whether this move encourages equity inflows back into the economy on the basis that Asia is reflating," said Jonathan Cavenagh, FX strategist at Westpac in Singapore.

Higher lending ahead?

Indonesia’s economy is expected to post solid 6.6% growth this year as exports remain strong in spite of a global slowdown. The country had annual growth of 6.5% in the first half on buoyant household consumption and investment.

Nasution said full-year loan growth was seen holding up at 24-25%, a figure bank executives expected to be boosted by its latest move and the possibility of a further cut.

“If inflation is manageable, the BI rate still has room to decline. The exchange rate is manageable and credit demand will be bigger," said Jahja Setiatmadja, CEO of Bank Central Asia , Indonesia’s biggest lender by market value.

A consumer confidence index rose in September as consumers saw lower financing costs and slower inflation in coming months . Nasution said on Tuesday the central bank saw domestic consumption and investment staying strong in 2012, though exports were likely to slow on weaker global demand.

The country’s export growth slowed in August, but at 37% from a year earlier would still be in the envy of many. The country is the leading exporter of thermal coal for power, palm oil and tin.

Economists say Indonesia is in better shape to face a global crisis than it was in 2008 and will likely expand above 6% next year even with an international slowdown.

“While this might be authorities’ attempt at pre-emptively cushioning downside risks to growth, we still believe that the move was a tad premature given the need to support rupiah and contain volatility in the local markets. Strong loan growth and flush liquidity conditions could pose price risks going forward," said Radhika Rao, economist at Forecast in Singapore.