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We track four developments since the turn of the year.

Strong fiscal performance

Indonesia’s 2022 fiscal deficit narrowed sharply to -2.38% of GDP, well below budgeted -4.9%, according to the Finance Ministry. This would put the deficit back under the mandated 3% of GDP a year ahead of plan. Notably, deficits were also lower in 2020-2021 than the budgeted target, albeit to a smaller extent.

Revenue realisation reached 116% of the target, rising 31% yoy and ~16% above the target. Crucial tax revenues grew 31% yoy, whilst non-tax receipts jumped 28%, exceeding the target by a fifth. Revenue outperformance was a function of a) tax reforms including value added tax increase, one-off tax amnesty, tax on fintech P2P lending, and e-commerce players, amongst others; b) better economic activity and resource-based industries receiving a lift in corporate earnings; c) strong trade performance feeding through higher import taxes/levy earnings; d) windfall gains from commodity-linked tax and non-tax receipts.

Expenditure growth rose a slower 11% yoy, falling slightly short of the budgeted size. Spending needs were driven by higher subsidy allocations and measures to offset the fuel price hike. Despite that, subsidies and compensation to state companies totalled IDR551trn was much higher than the budgeted IDR 152.5trn, but lower than earlier projections of more than IDR600bn. Pandemic related spending added to IDR 396.7trn by end-year and is likely to be dialled down gradually. By Fitch’s assessment, Indonesia’s 2022 deficit is “below the 3.6% 'BBB' category median and would make the country one of the first governments in Asia-Pacific to return to pre-pandemic fiscal deficit levels”. This helped cut financing needs to IDR 580bn in 2022 (vs the budgeted IDR 840.2trn).

Based on the budgeted assumptions, state revenues will rise by 1% in 2023, with a 3% reduction in expenditure, pegging the deficit at -2.8%. Resilience in domestic growth, higher indirect taxes, and commodity prices (lower than in 2022 but steadied into Dec22) at the margin should help. Subsidy cuts and softer global oil prices will also help provide relief on the spending front. With a reorientation in expenditure priorities, expectations are that higher public investments will surface as a tailwind for growth this year, which we expect will curb populist tendencies ahead of the 2024 elections. Subject to economic conditions, there is a likelihood that the 2023 fiscal target will narrow to 2.0-2.5% of GDP, i.e., pre-pandemic range vs budgeted -2.84%, boding well for overall macro stability. Our forecast stands at -2.7% of GDP.

A strong handover from 2022 put this year on a firmer footing, as excess balance (SAL) is carried over, for instance ~IDR120trn vs IDR246trn in 2021. A smaller financing plan will also be conducive for the bond markets, particularly as the central bank will stop purchasing bonds in the primary market from 2023. Besides routine demand from commercial banks and long-duration players, foreigners gradually returned to rupiah debt. The first multi-tranche USD-bond for the year attracted strong interest.

Trade strength has more room to run

The goods trade surplus was on course to register a record of ~$55bn in 2022, marking a 55% increase from 2021. Strong gains in the non-oil & gas commodity export have helped offset the oil & gas deficit and imports picked up pace with economic activities. For 2022, we see upside risks to our current account surplus forecast of 0.7% of GDP.

This year, commodity terms of trade gains will narrow (goods trade balance estimated at $35bn), with the shortfall in the service components likely smaller on the tourism sector rebound and relief on transportation costs. China’s reopening theme has also helped to mark a floor for commodities, on expectations of a faster pace of growth this year. In 2023, we no longer expect a small current account deficit and see a third surplus of 0.2% of GDP. Strong investment flows and a trade surplus will help keep the basic BOP positive for a fourth consecutive year.

Broader BI mandate and the Omnibus push

The parliament approved legislation that widened Bank Indonesia’s mandate to include supporting growth and financial market stability besides officiating their bond purchase program under any crisis situation, as part of the Finance Bill that was passed in mid-Dec22. Basis these changes, we don’t anticipate any change in the central bank’s policy bias, as policymakers weigh inflation risks, global rate movements, and currency direction.

Separately, the government signed off an emergency regulation in late-Dec22 (Government Regulation in Lieu of Law (Perppu) Number 2 of 2022) to replace terms of the Omnibus/ Job Creation Law, with a parliament endorsement required by the end of the next sitting to be treated as a law. This comes after the Constitutional Court deemed the legislation flawed last year and ordered a reassessment within two years. The Law covers several key aspects impacting the labour markets, including regulation of minimum wages, severance pay, and regulation on layoffs, amongst others.

To placate the trade unions, a few proposed changes revolve around limiting outsourcing to certain sectors and tweaking the formula to set minimum wages by adding a factor to consider purchasing power (press). This emergency decree is expected to attract resistance from labour unions yet again. Rigidity in labour market laws is viewed as one of the hindrances to a structural improvement in domestic and foreign direct investments.

Last leg of the rate hiking cycle

At the mid-December policy review, Indonesia’s policymakers drew confidence from a peak in domestic inflation, just as volatility in global financial markets eased on smaller increases in the US Fed rates. The subsequent release of the Dec inflation numbers registered a small upside surprise of 5.5% yoy as moderation in food prices was accompanied by an end-year boost to service components and utility price adjustments by the country’s third largest province. While the headline inflation breached the BI target of 2-4%, core inflation was largely consolidative at 3.0-3.5%.

With inflation past its peak and US Fed expected to dial down its rate hike cycle this year, Indonesia’s urgency to undertake aggressive rate increases has also eased. Nonetheless, with the currency (-2.2% in 4Q22) unable to participate in the regional currency rally and inflation above the official target, BI has opted to maintain a tightening bias but downshift to incremental and less forceful increases of 25bp. We look for one rate hike this month and another in Feb23 before hitting a plateau at 6%, matching the quantum of hikes expected from the US Fed. Onshore liquidity conditions are likely to be kept conducive to maintain a pro-growth stance.

The central bank’s other priority has been to attract FX liquidity back to the onshore financial system. Back in Dec, BI had outlined plans to introduce a new FX monetary instrument intended to attract export dollar earnings in the onshore markets by offering competitive returns.

Besides boosting domestic FX availability, these inflows will support the currency and lower associated borrowing costs. Low returns have deterred foreign currency liquidity from returning to the domestic markets, despite a strong goods trade surplus year-to-date and record investment flows. There are indications that the pool of sectors required to reroute these offshore earnings back to the local system will be widened.

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