Main story: Bank Indonesia likely to keep rates on hold; growth to slow but stay resilient

Bank Indonesia kept benchmark interest rates steady this week and is likely to remain on hold until later in the year despite an imminent rise in inflation, but despite the central bank’s efforts and an improvement in the balance of payments, the economy likely will grow more slowly this year before a revival in 2014.

 

Vox: Investment climate unconducive short term but set to improve

 

Analysts and officials predict that although macroeconomic conditions have deteriorated, investment flows are set to double, and the investment climate should improve heading into next year.

 

Resources roundup: Trouble for Freeport but LNG windfalls could be in the offing

 

Freeport’s local unit suffered another setback as a mine tunnel collapsed and trapped dozens of workers, while there was positive news from the energy sector with a a potential windfall from natural gas sales to China and Korea, and a major oil supplier nation reiterating plans to invest in a refinery.  

Bank Indonesia likely to keep rates on hold; growth to slow but stay resilient

(The Insider Stories) – Bank Indonesia has kept rates unchanged at a record low 5.75%, its fifteenth consecutive meeting of standing pat, as it seeks to balance slowing economic growth with rising inflationary pressures, while the balance of payments improved as the current account deficit narrowed.

The central bank is likely to keep rates on hold until late in the year or early next year as it seeks to revive economic growth from a near-two-year low.

The expansion in GDP in the first quarter of the year was 6.02% from a year earlier, down from 6.12% in the previous quarter and well below the government’s full-year target of 6.8%.

The rate decision was in line with the forecasts of 21 economists polled by Bloomberg News.

Dow Jones Newswires said 10 economists it polled also unanimously predicted BI to stand pat on rates, while some expect BI to keep the policy rate unchanged until the end of the year and absorb liquidity by pushing interbank money market rates higher via increases to the rate on its Fasbi deposit facility, which are currently at 4%.

Analysts expect BI to begin increasing the Fasbi rate following an expected increase in subsidized fuel prices, which may be announced this month.

The government has indicated it may increase fuel prices to around IDR6,000-IDR6,500 a liter from IDR4,500/liter currently in order to prevent the budget deficit from widening too far.

The consumer price rose 5.57% in April from a year earlier, easing from a near two-year high of 5.90% the previous month.

“While inflation is still seen to be within the 3.5%-5.5% target for the year, we expect it to shoot up to 6.5%-6.8% if the government were to revise its fuel price higher.This could then trigger a policy response by the BI, and we still pencil in a 50 basis point rate hike in total for the rest of the year,” OCBC economist Gundy Cahyadi says in a note.

“We have estimated that, if the gasoline price is hiked by 44%, it would directly add about 2.7 percentage points to headline inflation, bringing the inflation rate close to 8% by the end this year. This implicitly assumes that the spike in food inflation during the early months of this year will subside significantly in the second half of the year as the government eases import restrictions on food,”Credit Suisse analysts wrote.

Inflation rate would be highly dependant on how soon the governmnet can secure the typically lengthy parliamentary approval and how much it would raise the fuel prices.

In a worst case scenario, Bank Indonesia Governor Darmin Nasution forecast inflation of up to 7.8% by the end of the year.  

TIS analysis:

Bank Indonesia is in a difficult position when it comes to balancing inflation and growth.

A fuel price hike seems inevitable within the next few months – while such a move will almost certainly be damaging to President Susilo Bambang Yudhoyono’s popularity ahead of a presidential election in which his Democratic Party already lacks a realistic candidate.

Yudhoyono is a savvy economic operator and will want to avoid the devastating effect on investor perceptions that would result from failing to reduce a subsidy load that he has said risks blowing the budget deficit out to 3.8%, or unduly delaying fuel price increases.

An upside surprise is possible in terms of a bigger-than-expected fuel price hike, with reports that the government is now considering an increase in the premium gasoline price to IDR6,500/liter instead of IDR6,000/liter, however at this stage it remains more likely that the government will stick to its original target.

Based on this, TIS is inclined to join the growing consensus that inflation will be well above the target level by the end of the year, although at this stage a rise in the CPI to 7% or slightly higher seems more realistic.

Still, this is a significant policy problem for Bank Indonesia, and a hike of at least 50bps to the Fasbi rate by year-end seems more than likely, and an increase to the benchmark rate will be a matter of last resort.

Bank Indonesia will likely accompany Fasbi rate increases with a policy of allowing a weak rupiah, with a move to IDR10,000 or more against the dollar not out of the question by the year end.  

Growth set to slow, but remain resilient

The slowdown in growth is likely temporary and while the government seems certain to miss its full-year target of 6.8%,

Indonesia remains one of Asia’s strongest economies and is predicted to be able to ride out the current conditions. With growth remaining slightly above 6% despite the slowdown, the first-quarter figures “underline the resilience of the economy, which has now recorded 10 consecutive quarters of growth between 6-7%,” London-based Capital Economics says in a note.

“The stability is mainly due to the fact that Indonesia is a domestically-driven economy. Exports are equivalent to just 25% of GDP, which is much lower than others in the region.”

TIS analysis: A more optimistic view is justified than current conditions appear to warrant. It’s highly unlikely that full-year growth will slip below 6% - which is a solid figure by any reckoning, especially in a time of global economic uncertainty.

The leadup to the 2014 election will see large amounts of cash being spent on campaigns and various projects, which likely will bump up next year’s GDP figure by a few percentage points on its own

(see below Vox story). Consumer optimism is high – in fact the highest of any country in the world, according to consumer research firm Nielsen.

The government has indicated it may adjust its growth expectations for this year downward to around 6.3%-6.5%, according to Vice Finance Minister Mahendra Siregar.

Even this target may now be slightly optimistic, and growth of 6.3% or lower is beginning to appear likely.  

Balance of payments improves moderately The balance of payments remained in a deficit in the first quarter of the year despite an narrowing in the current account to $5.3 billion (2.4% of GDP) from $7.6 billion (3.5% of GDP) in the preceding quarter, as the capital and financial account swung into a deficit from a surplus.

An improvement in the non-oil trade balance was due to weaker imports of consumption and capital goods, while headline figures showed the capital and financial account deteriorated dramatically, swinging to a $1.4 billion deficit from a $11.8 surplus in the previous quarter.

TIS Analysis: The BoP should continue to improve, reducing pressure on the rupiah, due to several factors. Primarily, the capital/financial account figures are distorted:

Bank Indonesia notes that it has begun supplying the majority of foreign exchange to state energy companies for their oil import needs, which has resulted in a large buildup in foreign reserves at commercial banks that has flowed offshore into foreign-currency assets.

With the burden of supplying Pertamina and PLN’s massive FX needs removed, commercial banks will be able to better target their FX holdings toward their portfolio requirements, and the large gap in the capital/financial account should diminish over the next few months.

A BOP deficit of less than 2.5% by next year is a feasible and manageable level (see below Vox story).

A plan by the government to renegotiate prices of LNG it sells to China from the Tangguh LNG development could also improve the BOP’s energy component (see below Resources roundup.)  

Vox: Investment climate unconducive short term but set to improve

(The Insider Stories) – Analysts and officials predict that although macroeconomic conditions have deteriorated, investment flows are set to double, and the investment climate should improve heading into next year. The following are some insights from the Mandiri Sekuritas and Mandiri Investasi’s Investor Forum 2013.  

Bank Mandiri chief economist Destry Damayanti: On investment: “It’s probable that foreign investment inflows will be double last year’s levels. Foreigners still see plenty of scope for investment as there are growth prospects and valuations are good.

In January-to-May, foreign inflows to Indonesia [financial markets] were $5.8 billion compared with $6 billion in the whole of 2012, while outflows were $1 billion. The bond market attracted $3.8 billion [in January-May inflows] while in 2012 full-year inflows to bonds were $4.1 billion.

There is a lot of global capital [that can be deployed], and interest rates are falling. Emerging markets are the prime destinations, especially Asia, led by China, India and the ASEAN countries.”

Head of the finance ministry’s Fiscal Policy Office (BKF) Bambang Brodjonegoro, in a speech at the Mandiri forum: On fuel subsidies: “If premium [subsidized gasoline] rises to 6,500 rupiah and diesel to IDR5,500 inflation this year will be around 7%-7.5%.”

This is in line with a TIS forecast earlier this monthfor inflation of at least 7% by the end of the year. On the state budget: “As government spending never reaches as high as 90%, we will have a surplus that can be carried over to the 2014 budget.” On economies in the region: “China has settled on a GDP [growth rate] of 8%, and India faces internal obstacles so growth will be 5%-6%.”

Independent Economist Faisal Basri from the University of Indonesia:

Political observer Burhanuddin Muhtadi from the Indonesia Survey Institute (LSI): On the presidential election: “There are many impediments related to politics that have caused us to lose momentum.

The 2014 election will cause political fragmentation among the parties.

The election winner only needs 20% [support from each province] and will be helpless in making policy because the number of parliamentary factions will increase to 10, and each faction will control only 3.5% of voting rights. Consensuses will be difficult to reach as there will be a lot of dealmaking.”

On likely frontrunners:“If Jokowi isn’t nominated then possibly [Great Indonesia Movement Party (Gerindra) head Prabowo Subianto] will be elected. The constellation of candidates is still in flux and changing.

Oil supplier Azerbaijan may build $4.8 billion refinery Major oil supplier Azerbaijan could be set to bring Caucasus oil-industry expertise to the country, with Azerbaijani ambassador to Indonesia reiterating a plan by the country to develop a $4.8 billion refinery on Riau island, which would provide a much-needed boost to Indonesia’s stagnant refining industry.

Tamerlan Karayev is quoted as saying at an embassy event that State Oil Co. Of Azerbaijan Republic (SOCAR) is in negotiations with OSO Group, also known as PT Citra Putra Mandiri, which is based in Jakarta and has diversified interests including palm oil, property and mining, for the project, although there is no final decision yet.

Previous reports have said that Azerbaijan, which exports around $2 billion worth of oil to Indonesia a year and is the country’s eighth-biggest supplier, is planning a refinery with capacity of around 600,000 barrels a day, to be completed by 2017.

While Azerbaijan’s energy industry was dominated by Soviet state giants for decades, the country has opened up to foreign investors and its oil and gas sector receives massive amounts of exploration and development investment from global players like ExxonMobil, BP and StatOil.

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