Indonesia signals growth before rupiah's strength

Indonesia signals growth before rupiah's strength

SINGAPORE (Reuter): Indonesia's latest interest rate cuts are designed to signal that it is not prepared to defend its currency, the rupiah, at the cost of economic growth, analysts in Singapore said.

The central bank of Indonesia cut domestic interest rates on its short term certificates (SBI) for periods of one week and above by 50 basis points on Friday.

"The Indonesians don't want the sacrifice that currency defense entails," said Vincent Low, fixed income strategist at Merrill Lynch.

The central bank cut seven-day interest rates to 9.5 percent, two week rates to 10 percent and one month money to 10.625 percent. But it left the overnight SBI rate at a steep 14 percent to help prevent a sudden fall in the currency.

"In the wake of the baht crisis, central banks around Asia are looking for an optimal mix between exchange rates, interest rates and economic growth," Low said.

"Implicit in the Indonesian move is a signal that they don't want to see weaker growth."

The Indonesian rate move came the day after a rout on the Jakarta stock market, where the key composite index on Thursday suffered its second steepest intra-day fall. The index ended the day down 3.13 percent, but steadied a bit on Friday to finish the week down by around 6.5 percent.

"The Indonesians have been supporting their currency by high interest rates, and this caused a crack on the stock market," said Desmond Supple, head of Asian currency research at BZW Asia.

The looser monetary policy signaled by Friday's move helped the dollar strengthen against the rupiah, but demand for rupiah by state banks in Jakarta has kept the rate near the 2,600 level.

"The Bank of Indonesia put across the view (last) week that the tight liquidity conditions would ease, and also reaffirmed its commitment to the flexible exchange rate and that helped to calm sentiment in terms of the rupiah market," said Andrew Dermot Fung, regional treasury economist at Standard Chartered Bank.

One dealer at a U.S. bank in Singapore said: "The central Bank has indicated it's happy with a range between 2,555 and 2,610." The Bank of Indonesia's official permitted trading band runs from 2,378 to 2,682 rupiah to the U.S. dollar.

With the rupiah at the weaker end of the current ranges, speculation has arisen in Singapore markets about whether the bank would defend the official trading band if the rupiah were to fall further.

But after Friday's move on interest rates, analysts doubt the central bank would fight to hard to save the existing system.

"Even if they were looking to do something with the band, the next logical step would be to do away with it altogether," Fung said.