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Bank Indonesia extends pause

Decision and economic assessment

Bank Indonesia left the benchmark rate unchanged at 6% on Wednesday. The Governor expressed confidence on Indonesia’s growth, reiterating its estimates of 4.5-5.3% for 2023 and a higher 4.7-5.5% for 2024. The BI’s base case is for the US Fed to keep rates on hold in 1H and cut three times in 2H of the year. Considering this, the authorities likely saw reason in extending the pause on rates and prioritising rupiah stability through a multi-pronged approach – maintain rate differentials, need-based stabilisation measures and intervention. The Bank is also focused on boosting dollar supply and deepen money markets via capital management measures, following up with export earnings rules and new FX instruments announced late last year. At last count, the outstanding IDR-based SRBIs stood at IDR 296trn and dollar-denominated SVBIs at US$ 896.5mn (Indonesia rates: New instrument to attract inflows).

Policy outlook

Market participants are divided on the path ahead, and we see merit in a backloaded move to ease rates in 2H24.

Inflation has been well managed in second half of 2023, with base effects helping to cap headline CPI at below-3% by end-2023, staying within the headline. Higher food costs have met proactive administrative measures and food security measures, apart from stepped up (rice) – see chart- imports. Core has been weaker at sub-2%. We expect 2024 inflation to average 2.8% yoy, marking a higher 1H24 average of 3.0-3.5% before trending down.

This has left the real rates (see chart) in a sharply positive territory in the past six months. With inflation expected to tick up in 1H24, the positive real spread with narrow from 3.0-3.5% to 2.5-2.8%, still leaving ample room to ease rates.

However, US-ID policy rate differentials are still substantially narrow, convincing foreign investors to monitor the macro environment closely. Notwithstanding a supportive inflation outlook, a repricing in US rate cut expectations have kept the UST yields in a choppy range. US dollar has also entered a consolidative phase after a sharp correction late last year, leaving USDIDR bid in 15500-15700, despite a jump in the foreign reserves to near record highs. Against this background, the central bank is unlikely to have any impetus to provide dovish guidance or bring forward policy easing, until clarity emerges on the exogenous developments. The election cycle gets underway in February, with the current private opinion polls suggesting a second round around June 2024 is still probable.

Fiscal consolidation on track

Alongside a tight monetary policy, fiscal consolidation is also being prioritised. Indonesia registered the smallest budget deficit since 2011 at -1.65% of GDP (IDR 347.6trn) in 2023, better than the revised -2.3% and initial budget estimate of -2.45% of GDP (IDR 598.2trn). Revenue growth 5.3% yoy outpaced the 0.8% yoy rise in expenditure in the year. Excluding grants, the pace of total revenue growth was 5% yoy, slowing notably from 31% in 2022.

The 2023 tax revenue registered 8.9% yoy increase, led by direct as well as commodity-driven receipts. Non-tax revenue rose to a record high, albeit a moderate 1.7% on the year, on higher royalty earnings, despite a moderation in commodity prices. Meanwhile, higher dividend payments from state-owned enterprises in both banking and non-banking sectors also contributed to this lift. This nonetheless marks a slowdown from average 31% in the past two years.

As a % of GDP, domestic tax revenues are still hovering around 10% (see chart), lower than the earlier part of the decade, but recovering sharply from the lows during the pandemic. The expenditure breakdown saw the mix shift towards non-energy subsidies (food), rice imports, personnel, and regional transfers.

For 2024, the deficit goal is set at IDR 522.8bn (-2.29% of GDP), backed by tax revenue target of 6.3% yoy, in line with the pre-pandemic average. Expenditure is estimated at 6.4% yoy, notably higher than 2023, and likely driven by pre-election boost, personnel, social security measures and lower energy subsidies. While the weaker pace of government spending vs budget poses downside risks to growth, resilience in revenues will be key to watch especially if commodity prices correct further.

Lower risk of bond over supply

That said, Indonesia faces a lower bond supply risk in 2024, according to our assessment.

Firstly, lower budget realisation has resulted in a moderation in cash financing usage, allowing the government to scale back borrowings, as has been the case at the end of the last two years. Accordingly, total fiscal financing is down 40% yoy in 2023 at IDR 360trn vs 2022. Secondly, the cash financing allocation (SAL) has been pegged at IDR 51trn for 2024, though we suspect that the incremental cash buffer might be at least double by end of the year. Next, gross financing is pegged at IDR 1266trn and net at IDR 666trn, with both likely to be lower based on our revised deficit forecast at -1.8% of GDP this year – see chart (risk of an even narrower gap) vs budgeted -2.3%. Lastly, markets also expect a higher non-debt financing and loan program, helping to cut total bond issuance.

In this light, we view the government’s plans to raise as much as IDR240trn in 1Q24 (IDR36trn weekly), higher than 4Q23, as a move to frontload borrowings. As of mid-Jan24, the government had issued 7% of the 2024 bond financing target. Indonesia also raised $2.05bn this month via three tranches of benchmark dollar bonds (5Y, 10Y and 30Y) at the start of the year. This comes closed to the heels of $2bn raised via US dollar sukuk/Islamic bonds in Nov23. These foreign currency bonds also help to support the balance of payment position, notwithstanding ample IDR cash balances. With expenditure to fall short of targets, especially with elections dominating the narrative in the year, which will also concomitantly lower total financing requirements.

In all, these dynamics will lower IDR bond market volatility, just as the market participants remain focused on the timing and scale of the US rate easing this year. We remain positive on the IDR fixed income space, expecting the short-end and long-end rates to ease by end-2024.


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