While Brazil surprised the markets with a bigger-than-expected interest rate cut, South Korea and Indonesia on Thursday delivered exactly what had been predicted.

The Bank of Korea and Bank Indonesia both left rates unchanged – in a clear sign that concerns about the impact of rising oil prices on inflation are matching worries about the threats to global growth coming from the eurozone. It’s a striking shift for Indonesia, which has – like Brazil – been a standard-bearer for aggressive pro-growth rate cuts.

The Korean central bank left its key benchmark rate at 3.25 per cent for the ninth month in succession, and left economists thinking that it would stick to this steady-as-she-goes approach for at least the first half of 2012.

Bank Indonesia kept its benchmark overnight rate at a record low of 5.75 per cent, after a surprise 25 basis points cut in February, following earlier reductions in October and November.

The Bank of Korea started its statement by highlighting the global risks to growth:

Based on currently available information, the Committee considers some economic indicators in the US such as employment to have sustained their trends of improvement, but economic activities in the euro area to have remained sluggish. Growth in emerging market economies has continued to exhibit signs of weakening, due mostly to slowing exports. Going forward the Committee expects the pace of global economic recovery to be moderate, and judges that risk factors still exist, including the sovereign debt problems in Europe and geopolitical risks in the Middle East.

But it matched this with a warning about the threats in the oil market coming from the Middle East:

In the coming months, factors including the easing of demand-side pressures will work in favor of price stability, but the Committee recognizes the presence of potentially destabilizing factors such as the ongoing high inflation expectations and the geopolitical risks in the Middle East.

The Bank of Indonesia indicated in a statement that it was focused on the likely impact on inflation of a planned fuel subsidy cut, expected in April.

Bank Indonesia estimates the impact of a government plan in fuel will be temporary (a one-time shock) and inflation will decline again according to economic fundamentals. Bank Indonesia will take policies needed to anticipate the short-term inflationary impact by strengthening monetary operations to manage short-term excess liquidity.

Leif Eskesen of HSBC wrote in a note:

The BI likely wanted to pause to monitor the impact of the aggressive rate cuts undertaken so far, possibly also taking a little comfort from the recent stabilization in global economic conditions. The weakening of the currency since the last monetary policy meeting likely also played a role. Finally and importantly, the planned increase in energy prices (subsidized fuel prices by up to 33%) also kept them on the sidelines until there is more clarity about the exact change and timing.

Looking ahead, the BI may still ponder one more rate cut, but the inflationary risks associated with the hike in energy prices and the tightening of capacity on the back of strong growth could dissuade them.

The central banks’ move barely stirred the markets. Seoul’s Kospi stock index closed 0.9 per cent up. The Korean won edged 0.5 per cent higher to 1117.7 against the US dollar. The Indonesian rupiah weakened by 0.3 per cent to 9135. The Jakarta stock market close 0.6 per cent higher.

Inflation is currently falling in Korea, easing to 3.1 per cent last month from 3.4 per cent in January, within the central bank’s target of 2-4 per cent. However, even aside from oil prices, inflationary pressure is not abating, as transport, housing and clothing costs are all rising. GDP is forecast by the central bank and government to rise 3.7 percent this year after 3.6 per cent last year.

In Indonesia, a surprise fall in inflation to 3.6 per cent in February – its lowest for nearly two years – has allowed the central bank to try to stimulate growth with rate cuts. But the fuel subsidy cut will now raise consumer prices. The finance ministry has lifted its 2012 inflation forecast to 7 percent. The central bank predicts GDP growth to slow to 6.3 per cent in 2012, from 6.5 per cent last year.

Emerging Asia, including Korea and Indonesia, has overtaken the US as the world’s biggest oil consumer. Aside from oil-rich Malaysia, most countries are big oil importers.

Korea’s case highlights the economic vulnerabilities. “If oil prices rise to $150 [compared to $124 a barrel now for Brent crude], inflation will accelerate by 0.5 percentage points and growth will fall by 0.5 percentage points,” Kim Choong Soo, the Bank of Korea governor, said on Thursday, according to Bloomberg.

With Indonesia now deciding to hold fire with further cuts, albeit mainly for domestic considerations, other central banks in Asia may follow suit, faced with the common challenge of oil prices. The Philippines cut rates last week, but officials hint it won’t do so again for a while. The exception may be Thailand, where the economy is still struggling to recover from the floods.

Global growth worries have eased a bit. While Europe is stagnant, US demand, including demand for Asian exports, is stronger than had been feared. China is slowing, with Beijing announcing a 7.5 per cent growth target for 2012 this week, but from a very high level.

So the dangers of a hard landing seem much smaller than in Brazil, where the central bank cut rates on Wednesday by 75 basis points to 9.75 per cent, more than the 50 basis-point reduction that had been widely forecast.

The monetary policy committee split five-two, showing that the members weren’t unanimous about the seriousness of the threat of economic slowdown. But clearly they were far more worried than their counterparts in Seoul and Jakarta.

Related reading
S Korea: an emerging debt favourite, beyondbrics
Investing in South Korea 2011, FT
South Korean groups ramp up foreign deals
, FT
Indonesia’s surprise cut: more to come, beyondbrics
Indonesia cuts rates to protect growth, FT

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