Indonesia’s central bank cut rates by 25 basis points to 5.75% on Thursday.  A very surprising move, the rate cut caught a lot of market analysts and traders by surprise given that the Indonesian economy has actually been growing at a torrid pace.  Fourth quarter results showed that Indonesia grew by about 6.5% annually – making it approximately 8 straight quarters of above 5% expansion.  The US is on track for sub 2% growth.

So, what are they thinking?

Policymakers noted that the pace of growth isn’t the problem.  It’s keeping that pace of growth continuing that prompted the rate cut decision.  Even with current economic fundamentals the way that they are, many of Indonesia’s officials are saying that recent inflationary and growth measures allow for such a cut.

Although it’s very similar to what has been seen in Asia – with central banks from South Korea to Taiwan considering stable to lower rates – the actions of Indonesian policymakers are similar to another central bank in Brazil.  Aside from tougher quarters in 2009, the Brazilian economy actual grew at a pace of about 6.5% annually for much of the last 4 years.  However, concerned about the prospect of a slowdown, Brazilian central bankers began cutting interest rates – supplemented by government enacted tax cuts – in order to shield the country from a hard landing.  The measures have resulted in 12% decline in the real versus the dollar – while boosting Brazilian equity markets by 28% since the campaign start in October.

Could this be a revisit of the same scenario?

More than likely – at least on the currency end.  Without higher interest rates, global investors of foreign assets really don’t see the value in holding currencies like the Brazilian real and the Indonesian rupiah.  This is especially true given central bankers in Indonesia are likely to cut again – in order to preserve their economy –  prompting a rupiah that could take a far greater hit at this point.  Already lower by 7% since last summer, any further weakness is likely to come on a technical break above current support 9100.

However, the saving grace could be a reversal of the current sentiment as the lower rupiah could spur higher inflation in the country (rising above the top end of bank estimates at 5%) – instead prompting officials to reconsider their rate cut decisions.  But, for now, it’s not looking good for the exotic.

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