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Bank Indonesia extends pause

Decision: Bank Indonesia left the 7-day repo rate unchanged at 3.5% on July 21, remaining in an extended pause 1Q21. Similar to last month, the central bank exhibited little urgency to join global and regional peers in tightening policy, as domestic considerations are given a higher weightage in the policy mix. This makes Indonesia, besides Thailand (DBSf: first hike expected in August), outliers in ASEAN-6 (ASEAN-6: Rising food prices and inflation worry) to have kept rates unchanged yet far in this cycle.

Economic assessment: The central bank’s economic assessment for global and domestic outlook carried few notable changes. Views on global growth were downbeat, as the growth forecast was cut to 2.5% yoy from 3.5% earlier. Domestic growth was pegged at 4.9% for 2022 (4.5-5.3%) at the lower end of the previously held range. Our forecast stands at 4.8%. The view on inflation remained unchanged as BI maintained that pressures were supply-led, with the headline print expected to breach the inflation target this year (might reach 4.5-4.6%) before returning to range in 2023. Core was expected to stay with 2-4%. Current account forecasts were revised up, now expecting +0.3 to -0.5% of GDP vs -0.5 to -1% of GDP earlier. Loan growth was revised up to 9-11%, with June’s pace at 10.7%.

Outlook: Bank Indonesia stuck to script, as their pre-conditions (see note) for a start to the rate hiking cycle are yet to be met. Despite the rupiah’s 5% year-to-date depreciation against the dollar, the currency is amongst the regional best performers, besides the SGD and HKD. Rupiah’s underperformance was put on the uncertain global financial markets, whilst the upgrade in the current account forecast implies that the currency enjoys a structural tailwind this year. Concurrently, headline inflation tested past the target range in June, but the core hovers at the sub-3% level. A second consecutive month of above-target inflation in July (~4.7-4.9%) is unlikely to be a game changer for the authorities as they have already flagged the risk of an overshoot on higher food and fuel while core lags the lift.

With core inflation expected to test above 3% around late-3Q, that might be a likely timeline when hikes are back under consideration. We revised our rate forecast to one 25bp this quarter and two 25bp in 4Q22, compared to the earlier call for two in 3Q and one in 4Q.

Liquidity absorption, including allowing money market rates to rise, meanwhile, leads policy normalisation efforts, apart from regular market operations to mitigate volatility in the domestic financial markets. Cash conditions are being normalised via reserve requirement ratio increases, which will reach 9% by Sep22. Higher RRR has reportedly absorbed IDR219trn worth of liquidity so far. BI has also started to reduce its bond holdings (IDR390bn, i.e., $26mn sold earlier this week), a move viewed as a precursor to an outright rate adjustment.

The decision to hold out on policy tightening moves against the backdrop of rising rates by global/ regional central banks have reflected in the markets’ price action. The cushion of real rates (inflation – policy rate) has turned red, vs a comfortable positive at the start of the year. Rupiah broke below 15,000/USD this week, lifted by a surge in the dollar index, notwithstanding active official presence to defend against selling pressure.

After a period of stabilisation, IDR 10Y bond yields have also begun to rise, with a weak weekly auction adding to its buoyancy. Borrowing targets have been missed in the past four consecutive auctions.

Inflation to dominate the 2H narrative, 2022 fiscal math in a stronger shape  

With June’s CPI inflation quickening to a five-year high, this narrative will dominate in 2H22. The food segment accounted for much of the uplift, apart from transportation. As discussed in High subsidy budget leaves Bank Indonesia with more headroom; prices of commonly-used fuel and electricity variants remain on freeze, absorbed via higher subsidies. Non-subsidised energy, meanwhile, continues to be adjusted up. State-owned PT Pertamina raised the prices of Pertamax Turbo (+10%), Dexlite (13.6%) and Pertamina Dex (17%) this month, besides 12kg LPG and Bright Gas. The smaller weight of these fuel products in the consumption basket will limit the spillover onto headline inflation. Given the fluid path of commodities, higher food, the reopening’s boost to demand, and passage of price increases, we see inflation average 4% in 2022. Core will likely average 2.7% in the year, with readings to rise above 3% in the latter part of the year.

The government expects the 2022 fiscal deficit to be sharply lower at -3.9% of GDP (IDR 732.2trn) vs earlier indication of -4.5% and budgeted -4.85%. This effectively signals that this year’s financing needs might be lower than the projected IDR 991.3trn worth of borrowings.

This could provide some interim relief to the bond market, as 10Y yields rose ~22bp in the past week, heading towards this year’s high. Jan-Jun22 fiscal balance stood at a small surplus of 0.4% of GDP on the back of 55% yoy jump in tax revenues. This had led the Q3 debt issuance target to be lowered to IDR 147trn vs Q1 and Q2 targets of IDR 241trn (IDR 209trn realized) and IDR 154trn (IDR 125trn) respectively, besides a private placement between the MoF and BI under the burden-sharing program last quarter.

Year-to-date bond issuances total ~40% of the gross budgeted quantum. Domestic players hold more than half of outstanding bonds, while the share of foreigners has slipped below 16% from 37-38% in early-2020. Meanwhile, June reserves were up by $0.83bn to $136.4bn, keeping import coverage supported above 6months. On most macro stability metrics, the economy continues to fare well this year, with a strong trade account providing an important tailwind. The trajectory of commodity prices, slowdown risks in the US/ Europe and US dollar direction will be key determinants for the emerging markets’ price action in 2H22.

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