·         The current account deficit in 3Q narrowed to $8.4bn — This is eq. to 3.8% of GDP by BI’s calculation or 3.9% if converted using the avg. monthly exchange rate. It is slightly higher than our expectation of $8bn or 3.7% GDP. The improvement was largely attributed to a narrower merchandise trade deficit, as non-oil and gas imports came down.

·         FDI relatively strong at $5.4bn, but the basic balance deficit hasn’t reached comfortable levels yet — Incoming FDI was supported by a rise in net intercompany transfers. FDI managed to cover 60% of the current account, which is an improvement vs. only 38% in 2Q. However the CA deficit – FDI gap in Jan to Sep was on average about $3.8bn per quarter, which still looks high compared to portfolio inflows of about $2.5bn per quarter (2-yr average). Further lowering this basic balance deficit is imperative given the expected Fed tapering next year.

·         We expect a CA deficit of around 3.5% of GDP in FY13— We expect to see another reduction in the 4Q13 CA deficit to 2.9% of GDP. The turnaround may gain additional momentum after the recent uptick in a number of export commodity prices, e.g., palm oil and coal to a lesser extent. We are also expecting a further decline in non-oil and gas imports as domestic prices of imported goods continue to adjust (at both producer and consumer price levels) and the effects of higher interest rates kick-in.

·         But caution: Fuel trade deficit concerns may resurface — We are growing more cautious again on the oil trade deficit. During the quarter it actually widened QoQ and YoY (39%) to $5.9bn, in spite of the fuel price hikes in June. Although the government has projected that subsidized fuel consumption will not exceed the quota of 48mn kl this year, domestic oil production continued falling to 821kbpd in 3Q (-4% YoY). This must be closely monitored as motor vehicle sales have rebounded back to double digits in Sep and Oct, supported by the recent tax breaks on small cars.

·         It’s not time to throw in the towel yet for policymakers — BI will likely look into further potential macroprudential measures to curb lending growth, and we also expect another 25bps hike in 1Q14. However with risks potentially resurfacing on the oil trade deficit and BI effectively being the last resort guardian on the current account, we see growing upside risk to our rate forecast. The government may have its hands tied next year with regard to raising fuel prices (due to the elections), and it remains to be seen whether the mandatory biodiesel substitution program can progress as quickly as needed.