(TIS) – A number of warning signals sounded this week for Indonesia’s economy, with stalled reforms and a seeming lack of willingness by the palace to take swift action on issues like fuel subsidies putting a long-awaited sovereign rating upgrade at risk, while a forecast that weak commodity prices will keep growth near two-year lows threatened to overshadow the relative bright spots of a softening of inflation and an upswing in consumer confidence.  

Government stalls on fuel prices President Susilo Bambang Yudhoyono was expected to announce a fuel price increase Tuesday but instead told a meeting of central and regional government officials that the policy won’t be announced until targeted subsidies for the poor, which could include cash payments, rice or education subsidies, have been decided in budget deliberations with parliament, likely before the end of this month. This is not a development that investors will find encouraging – negotiations failed with The People’s Representative Assembly (DPR) over a planned fuel price increase last year.

DPR is often criticized as having high levels of corruption and incompetence and with a weakened president nearing the end of his final term there is little reason to expect talks will yield a timely, focused policy outcome.

TIS Analysis: While there is some elbow room, with inflationary pressures easing in March and expected by Bank Indonesia to stay milder until June, the broad market consensus is that the government should take advantage of this window by raising fuel prices early in order to soften the resultant inflation passthrough. By insisting on determining subsidies to offset the price hike before announcing the increase, Yudhoyono is putting the economy at risk for the sake of economic populism, with the net result that likely no one will benefit.  

Fuel price increase likely to be across-the-board

The palace also indicated that it favors an across-the-board fuel price increase rather than a previous proposal to implement a two-price system that would make fuel more expensive for cars than for motorcycles, the most common method of transport for poorer Indonesians.

TIS analysis: A more focused pricing system could more effectively channel subsidies to the poorer members of society and away from the wealthier – car owners benefit to the tune of around $100 a month from the current system while motorcycle owners benefit by about one tenth of that amount.

However blanket increases have been the norm in the past and are far easier to implement, as well as being in line with public expectations.

Given the failure of last year’s attempts to raise prices and the limited window of opportunity available both in terms of inflation and political will, a less complex policy that can be implemented more quickly and easily is likely the better choice this time around.

The palace has indicated prices won’t be raised to IDR6,500-IDR7,000/liter, previously proposed as possible maximum levels, however Bank Danamon expects an across-the-board 22% hike to IDR5,500 to still generate a 1.9% rise in inflation, pushing price gains beyond the 5.5% upper limit of Bank Indonesia’s target range.

Singapore-based Barclays Capital analyst Prakriti Sofat expects inflation to rise to 7% by the end of the year in the event of a IDR1,000 increase from the current IDR4,500/liter.  

Ratings outlook change sounds warning

Two significant warning signs appeared Thursday. Standard & Poor’s Ratings Service announced unexpectedly that it was revising its outlook on Indonesian government debt to stable from positive, diminishing the chance that S&P will act in the next 12 months to raise its sovereign rating in line with the other two major global rating firms, Fitch Ratings Ltd. and Moody’s Investors Service.

Fitch raised its rating on Indonesia to investment grade in December 2011 and Moody’s in January 2012, and while S&P was expected to follow suit it has kept its rating at BB+, its highest junk-grade level. With a relatively low per-capita GDP forecast of $3,800, the government has less room to implement fiscal reforms when maintaining creditworthiness would require unpopular policy moves, S&P said.

Alongside longer-term, more intractable issues like infrastructure development, it singled out fuel subsidies as key. “We may raise the ratings if reforms, such as a subsidy rationalization, suggest that fiscal and external vulnerabilities are sustainably reduced, the sovereign’s balance sheet improves, the external debt burden declines, or if structural reforms unlock faster economic growth,” according to S&P’s report.

“Conversely, we may lower the ratings if renewed fiscal or external pressures are not met with timely and adequate policy responses, or if future policies endanger strong growth prospects or the positive fiscal and debt trajectories.”  

TIS Analysis: S&P’s move on the rating outlook isn’t likely to generate a significant short-term increase in borrowing costs, which remain relatively low. Any impact to the broader economy if companies find it more difficult to borrow is likely to be offset by steady gains in domestic consumption and a flurry of spending by political parties ahead of next year’s elections.

However long term this is yet another warning sign for the palace that investors may take their money elsewhere if the much-needed reforms aren’t put in place. Notably, S&P concurrently raised its rating on Philippines sovereign debt one notch to investment-grade BBB-, indicating that Indonesia risks losing competitiveness with other members of Association of Southeast Asian Nations as the region seeks to form an economic bloc by 2015.

Commodity prices a risk to growth

Bloomberg News forecast in a poll that data due for release by the government on May 6 will show economic growth remaining near two-year lows as commodity prices hurt exports. Economists polled by Bloomberg gave a median forecast for 6.12% growth in the first quarter of the year from a year earlier, compared with 6.11% the preceding quarter.

TIS Analysis

It will be difficult for the government to achieve its 6.8% growth target for this year given the effect of low commodity prices on exports and cooling global growth. Deputy finance minister Mahendra Siregar is reported as saying the government may cut its growth target to between6.3% and 6.5% and this is probably a more realistic outlook.  

Inflation has eased, but may not stay down

Amid the economic gloom were a few positives. Wednesday’s inflation announcement was a welcome relief, as the consumer price index fell 0.1% in March from February’s level, in line with easing prices for garlic, gold and eggs – a bigger deflation than the 0.04% Bank Indonesia had forecast. The rise in the main inflation gauge also eased on year,  to 5.57% from 5.90% in March, mitigating a major overhang on the rupiah.

TIS Analysis

Core inflation, excluding prices of goods that are volatile or are administered by the government, was almost steady at 0.13% compared with 0.14%, and producers have yet to pass through electricity tariff hikes.

The government will have to increase fuel prices or risk blowing its budget deficit through the 3.0% ceiling that is the maximum allowed under Indonesian law, and given Yudhoyono’s ineffectiveness and the involvement of DPR in the process, this looks like it will happen later rather than sooner.

It appears almost certain that Bank Indonesia’s 5.5% target will be breached, with inflation of at least 6.5%-7%  by the end of the year appearing highly likely.  

Consumer confidence a bright spot Despite the gloomy economic environment, a Nielsen survey released this week showed that Indonesians are now the most optimistic consumers in the world based on self-reported economic indicators such as ability to find work, spend and manage personal finances, overtaking consumers in India.

Globally, consumer confidence in the first quarter of the year rose to 94 on Nielsen’s scale from 91 the previous quarter, with values over 100 indicating optimism and those under 100 indicating pessimism.

TIS Analysis Indonesian consumers are relatively sophisticated given the overall income levels in the country, and consumer perceptions can be a powerful predictive tool.

Amid a wave of middle-class optimism, Indonesian consumers and the companies that supply their needs continue to show signs of becoming a political and economic force that is able to drive change in government and underpin the economy even as necessary reforms stagnate.

In an economy that still exhibits symptoms of control by often corrupt elites, soaring confidence in the ability to find work, spend and manage finances indicates that most Indonesians are no longer happy to accept mismanagement and apathy from their leaders.