Philippines and Indonesia to partially unwind 2018 hikes

Bank Indonesia (BI) and Bangko Sentral ng Pilipinas (BSP) were two of the busier central banks in 2018, each hiking policy rates by 175 basis points as pressure on their respective currencies mounted. Central bank governors rushed to take action as concerns about ballooning current account deficits compounded anxiety over two global developments: the US-China trade war and the Fed's own rate hike cycle. Additionally, the Philippines was adjudged to be "behind the curve" as inflation zoomed past target to peak at 6.7% in September while Indonesia's bond market faced challenges as foreign players headed for the exit. 2019 however now features a Fed that is inclined to cut and not to hike, reshaping investor sentiment even if the US-China trade war appears far from over. As a result, investor concern about the still relatively wide current account gaps of the Philippines and Indonesia have receded, allowing both BI and BSP some scope to reverse at least some of the aggressive 175 bp rate hikes carried out in 2018 and help bolster growth momentum.

Both Indonesia and the Philippines are in the midst of an import binge as the respective governments look to push investment and upgrade infrastructure. Imports of raw materials for construction and capital equipment to carry out ambitious projects have taken their toll on the current account, with Indonesia and the Philippines recording relatively high current account deficits relative to GDP of 2.98% and 2.4%, respectively. The Indonesian government has been seeking to limit the current account gap by reducing imports and boosting exports. President Jokowi recently announced a raft of reforms to attract foreign investment, adding to a long list of projects aimed at boosting the Indonesian export sector, which should help the country hit its 2.5% current account to GDP forecast. For the Philippines, the current account continues to widen, with the BSP predicting the shortfall to hit 2.8% of GDP by year-end, as the government looks to bring in infrastructure related imports, albeit on a delayed basis due to the belated passage of the spending bill. Despite the still apparent current account gaps, market concern about the shortfall has abated, at least for now.

BI Governor Perry Warjiyo has been telegraphing a possible rate cut for the past few weeks, openly saying that "there is room to lower the rate" after a relatively positive year for the Indonesian rupiah, which has appreciated by 3.86% year-to-date. Inflation has been less of a pressing concern for the central bank as price gains have been muted so far and well-within the government target of 2.5-4.5%. For months we had gauged that any adjustments from BI's end would hinge on the stability of the IDR and with Fed Chairman Jerome Powell almost sealing the deal on an FOMC rate cut in July, we believe that Governor Warjiyo will have his opportunity to finally walk back a portion of his 2018 rate hike salvo. With re-elected President Jokowi calling for the government to help spur growth, the central bank will likely figure in this equation, as rate cuts will support economic activity and accommodate the investment climate that Jokowi seeks.

After initially cutting rates in May by 25 bp, the BSP opted to enact a "prudent pause" at the June meeting to ensure that inflation was in a downtrend. With the dovish Governor Benjamin Diokno repeating his call for rate cuts, we reiterate our forecast for a BSP 25 bp rate cut at the 8 August meeting and leave the door open for further easing in 3Q. Diokno has indicated that the decision to cut policy rates "had been made" and that the central bank is simply deciding on the proper timing. The Governor also noted that the BSP was taking into account the recent dovish tilt of the Fed, which could convince the BSP to reduce rates a total of 50 bp in the third quarter. Thus, the BSP may opt to slash policy rates by 25 bp at the 8 August meeting and 25 bp at the 26 September or Diokno can opt to cut policy rates by 50 bp at the August meeting.