Jakarta. Bank Indonesia (BI) increased the benchmark BI-Rate by 25 basis points to 6.25 percent, citing escalating geopolitical tensions in the Middle East and high interest rates in the US, causing the rupiah to weaken.

During its Board of Governors Meeting on April 23-24, the central bank also raised the Deposit Facility rate to 5.5 percent and the Lending Facility rate to 7 percent.

"This rate hike aims to strengthen the rupiah exchange rate amid worsening global risks and to ensure inflation remains within the target of 2.5 plus-minus 1 percent in 2024. It is in line with our pro-stability policy stance," said BI Governor Perry Warjiyo during a press conference after the monthly Board of Governors Meeting on Wednesday.

This is the first interest rate hike since October 2023 and was contrary to analysts' expectations.

Perry said that global economic and financial dynamics were rapidly changing due to increasing risks and uncertainties stemming from changes in US monetary policy and escalating geopolitical tensions in the Middle East.

"As a result, global investors are shifting their portfolios to safer assets, particularly the US dollar and gold, leading to capital outflows and further depreciation of currencies in emerging markets," explained Governor Perry Warjiyo.

According to Perry, high inflation and robust economic growth in the United States were fueling speculation of a smaller and longer-than-expected decline in the US Federal Reserve's benchmark interest rate (Fed Funds Rate/FFR), in line with statements from Federal Reserve officials. This, along with the US's increasing debt needs, has led to a continuous increase in US Treasury yields and a stronger US dollar globally.

"The strengthening of the US dollar is also driven by the weakening of several world currencies such as the Japanese Yen and the Chinese Yuan," added Perry.

Moving forward, risks related to the direction of the FFR decline and global geopolitical tensions will continue to be monitored as they could lead to further uncertainty in global financial markets, increased inflationary pressures, and decreased prospects for global economic growth.

"These conditions require a strong policy response to mitigate the negative impact of global uncertainty on the economies of developing countries, including Indonesia," said Perry.

Meanwhile, Indonesia's economy is considered resilient amidst increasing global uncertainty. Economic growth in the first and second quarters of 2024 is expected to be higher than in the fourth quarter of 2023, supported by strong domestic demand from household consumption in line with the seasonal Eid trend.

Investment in construction is higher than expected, supported by the continuation of National Strategic Projects (PSN) in several regions and the growth of private property due to government incentives. With these developments, economic growth in 2024 is estimated to be in the range of 4.7-5.5 percent.

"In the future, BI will continue to strengthen policy synergy with the Government, including through the Government's fiscal stimulus with Bank Indonesia's macroprudential stimulus, to support sustainable economic growth, especially from the domestic demand side," added Perry.

The rate hike was contrary to analysts' expectations, who anticipated BI to maintain its benchmark interest rate.

Teuku Riefky, an economist from the Institute for Economic and Social Research (LPEM) Faculty of Economics and Business, University of Indonesia (FEB UI), had recommended Bank Indonesia (BI) to maintain its benchmark interest rate at 6 percent to mitigate the impact of geopolitical tensions in the Middle East.

"The rupiah is currently facing significant currency pressure and a surge in capital outflows over the past two weeks, triggered by geopolitical tensions in the Middle East," said Teuku Riefky in Jakarta on Tuesday.

So far, the rupiah has depreciated by around 2.98 percent month-to-month or 5.5 percent year-to-date against the US dollar and is one of the worst-performing currencies compared to peer countries, only performing better than the Brazilian real in the last month.

"Although there is room for a benchmark interest rate hike, the decision to raise BI's benchmark interest rate does not seem to be the ideal step to take at this time," he added.

Head Economist of Bank Permata, Josua Pardede, said that if the BI-Rate is raised, the positive impact would be that the pressure from external factors could ease because there is an expansion of the positive spread with the yield of financial instruments from other countries, making Indonesian financial instruments more attractive due to compensation for the increase in risk premiums.

The negative impact is that the burden of yields on domestic financial instruments will increase and become a burden for instrument enthusiasts.

"In addition, the increase in the BI-Rate can lead to an increase in lending rates, thus increasing borrowing costs, ultimately potentially hindering Indonesia's economic growth potential," added Josua.