The Widening Gap Between BI's and the Fed's Benchmark Interest Rates: What are the Implications?

The gap between Bank Indonesia's (BI) benchmark interest rate and that of the United States Federal Reserve (The Fed) is narrowing.

BI maintained its benchmark BI-7 Day Reverse Repo Rate (BI7DRR) at 5.75% during the Governor's Board Meeting (RDG) on September 20-21, 2023. Concurrently, the deposit facility rate remained at 5% and the lending facility rate at 6.5%.

BI stated that this decision to maintain the benchmark interest rate reflects consistent monetary policy to ensure inflation remains under control.

Meanwhile, The Fed held its benchmark interest rate in the 5.25%-5.5% range in September 2023. The Fed last raised interest rates in July 2023.

Considering both central banks' benchmark interest rates, the spread or gap is approximately 0.25%.

According to Kontan.co.id, Maximilianus Nico Demus, Associate Director of Research and Investment at Pilarmas Investindo Sekuritas, highlighted the narrowing spread between BI's and The Fed's benchmark interest rates.

In 2020, the spread reached approximately 4.25%, then gradually narrowed to a stable point of 3.25%. Nico noted that the decrease in the spread was partly driven by Indonesia's strengthening fundamentals.

However, Nico also observed that Indonesia's credit rating remains at BBB, while the US rating is AAA.

"When the spread between the two narrows or even disappears, investors will choose the country with a AAA rating as their investment destination," Nico told Kontan.co.id on Sunday, August 20, 2023.

The 0.25% spread could potentially shrink further to 0%. Especially since The Fed may still raise interest rates in the coming months, as the US annual inflation rate rose to 3.7% in August 2023, far from The Fed's target of 2%.

Nico explained that the narrowing gap could lead to increased capital outflow. This could weaken the Indonesian Rupiah and the Jakarta Composite Index (IHSG).

Meanwhile, Senior Economist Anny Ratnawati also sees the potential for The Fed to raise its benchmark interest rate by 25 basis points (bps) at the end of October 2023. However, Anny prefers to consider the real interest rate.

According to CNBC Indonesia, Anny explained that BI's benchmark interest rate is 5.75%. Indonesia's inflation in September 2023 was recorded at 2.28% year-on-year (yoy). The difference between the two is almost 3.5%.

The Fed, with a highest benchmark interest rate of 5.5%, minus August 2023's annual inflation of 3.7%, has a difference of 1.8%.

"In real terms, we are still attractive to investors, but there is a risk of Rupiah weakening due to the 3.5% difference between BI's benchmark interest rate and inflation, minus the risk premium," Anny said in an interview on Tuesday, October 10, 2023.

Anny believes there is still room for BI to maneuver. She cautioned that all policies to be implemented must be coordinated and made effective with other relevant institutions, so that currency movements remain at a safe level or do not fluctuate excessively.

"My warning is that towards the end of the year (2023) there is potential for (economic) pressure. Debt and interest payments, imports, and others should be checked to prevent sudden jumps that burden demand and cause (Rupiah) movements to be far beyond our imagined weakening. Because the world is actually experiencing currency weakening, not just Indonesia," she said.

(See also: BI Maintains Benchmark Interest Rate at 5.75% in September 2023)