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BI extends pause

Bank Indonesia left the 7-day reverse repo rate unchanged at 5.75% for a third consecutive policy meeting, after 225bp hikes in this cycle. The lending facility rate stays at 6.5% and deposit facility at 5.0%.

Economic assessment

In post policy commentary, view on growth was upbeat, accompanied by expectations that inflation would ease faster than expected. Global growth forecast was maintained at 2.6% yoy, more conservative than the IMF’s 2.8% projection for this year. Domestically, growth is pegged at the firmer end of 4.5-5.3%, pointing towards positive growth differentials vs other emerging market and advanced economies. 1Q23 GDP is forecasted at around 5.1% yoy after 5.3% average in 2022.

Price pressures are expected to ebb at a more hastened pace than the earlier path, with the CPI to return to the 2-4% band by August (our view is June/July). With energy prices off last year’s elevated levels, negligible risk of further subsidy fuel price adjustments and administrative measures to prevent any dislocations in food segments, inflationary expectations are broadly anchored.

Credit growth is off highs but still firm at around 9.9%, with 2023 full-year average projected at 10-12%. Current account balance is seen at +0.4% to -0.4% of GDP range. Our forecast is for a small surplus.

Outlook

The current growth-inflation-currency backdrop provides little reason for the central bank to return to the rate hike cycle. Headline and core inflation readings have been on a steady decline in the past three months, with the headline on course to return to below 4% i.e., upper bound of the target range by mid-2023 and less than 3% by Sep23. The IDR has benefited from a pullback in the USD and positive flows outlook (year-to-date flows into debt has surpassed $3bn), also boding well for the BI’s price stability mandate. Rupiah is the best performer in the region on year-to-date basis at +4.9%, followed by the Indian rupee at a distant 0.9% (see chart).

Macro stability risks are benign at this juncture with a small current account surplus accompanied by a healthier financial account/balance of payments, insulated banking sector and a build-up in the foreign reserves stock. BI also plans to sign a bilateral local currency deal with South Korea’s BOK next month.

Evolving trends point to the likelihood of a shift in BI’s leaning in the coming months, with the policy to pivot towards rate cuts this year, rather than 2024. We bring forward our rate cut expectations, starting in Aug23 vs previous early-2024, with risks skewed towards an earlier start rather than later. Policy rate is expected to settle at 4.75% in 1Q24. This would see the BI stand out as the amongst the last to start rate hikes in the region, and amongst the first few to return to the easing cycle.


Fiscal position remains healthy

Indonesia’s fiscal math continues to remain on a strong footing, after beating expectations and returning the deficit to below -3% of GDP threshold a year ahead of schedule in 2022.

1Q23 budget balance registered a surplus of 0.6% of GDP (IDR 128.5trn) – see chart, owing to 29% yoy jump in overall revenues and slower 5.7% rise in spending. Strong non-tax and tax revenues contributed to this outperformance, rising 43.7% and 25% respectively.

Key revenue sub-segments point to mixed trends – imports related receipts are slowing, easing export trade driven earnings (customs and excise revenue was down ~9% on slower exports of palm oil and minerals), alongside softer collections under the value added tax, pointing to moderating demand. At the same time, non-tax revenue still rose by a stronger clip (19.4% yoy) on commodity-related earnings, especially coal.

Under expenditure, about ~17% of the annual budget has been spent by Mar23, less than the 26% of revenues that has already been raised in this period. Central government’s spending rose 10%, whilst that of regional transfer contracted. Allocations towards energy subsidies stood at IDR24.5trn, lower than comparable period last year, likely due to last year’s price adjustments and lower realised oil price to-date. Additionally, disbursement towards the annual Holiday Allowance (THR) to the state employees ahead of the Ramadan period was also undertaken in this period. Year-to-date performance might lead the full year fiscal deficit to a narrower -2.0-2.2% of GDP, better than budgeted figures.


Market implications 

A fiscal surplus in 1Q23 provides the room to reduce financing needs, resulting in a lower 2Q bond auction target at IDR 130tn vs realised IDR 221tn in 1Q (vs initial target IDR245tn). With a third of the full-year’s debt financing requirement already completed by 1Q, authorities have ample headroom to time issuances, lessening the need to upsize borrowings. Cash buffers were also built last year to defend against the risk of higher borrowing costs. Apart from keen domestic interest, foreign bond purchases have resumed, pushing up the share of FII ownership of outstanding IDR bonds to 14.9% in Mar23 vs a record low of 13.9% in Oct22 (see chart).

Our Rates Strategists are constructive on IDR bonds, on a benign inflation backdrop, extended rate pause, and comfortable onshore liquidity. Even as current valuations are in rich territory, if there are indications that the authorities are warming up rate cuts and/ US Fed starts easing rates in 2H would present opportunities in this space.


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