February 15, 2013 Exclusive Analysis: Indonesia Market Update Research Team Ryan Hakim Economist rhakim@cascadeasia.com Manuel Pakpahan Director, Investment Strategy manuel@cascadeasia.com Bank Indonesia Rates not going anywhere 2012 current account deficit Surprise, Surprise 2012 growth What s wrong with this picture? Steady bonds, extended equity rally What is the possibility of a rise in FASBI rate? Expect bond yields to remain low Equities to lose steam soon? Bank Indonesia Rates not going anywhere Bank Indonesia chose to keep the BI rate unchanged at 5.75% for the 12th consecutive month at its monetary policy meeting on February 12 th, in line with CAA s expectations. Growth slowed to 6.1% y/y in Q4, clocking real GDP at 6.2% for 2012. We expect private consumption to be supported by the recent double-digit increases in minimum wages, while public spending is likely to rise in the second half of the year as campaigning begins for the 2014 legislative election. As for CPI, prices remained moderate in January at a reported 4.6%. With extensive flooding in Jakarta and other areas in Java and Bali however, we expect food prices to hike, while the minimum wage increases will likely spur demand-pull inflation over the next few months. BI will surely monitor inflationary developments closely, as it is currently battling the 6% fall of the rupiah against the dollar last year. If rupiah depreciation begins to stoke inflation, we may see an upward shift in BI s rate policy. Cascade Asia Advisors PO Box 51194 Seattle, WA 98115 info@cascadeasia.com www.cascadeasia.com As we have alluded to in past commentary, weak export demand, strong import demand and accelerated external borrowing will also affect BI s stance on rates. However, barring a change in the government's subsidy regime (which we don't foresee), we believe inflation should remain stable Copyright 2013 Cascade Asia Advisors. All Rights Reserved. Page 1
Q1 2009 Q1 2010 Q1 2011 Q1 2012 enough to keep the benchmark BI rate at its current 5.75% at least until H2 2013. 2012 Current Account Deficit Surprise, Surprise On February 13 th, Bank Indonesia recorded its first annual CA deficit since 1997, clocking in at USD 24.2bn (2.7% of GDP), compared to a surplus of USD 1.7bn (0.2% of GDP) last year. Merchandise trade fell from USD 34.8bn in 2011 to USD 8.4bn in 2012, and was the main reason for the deficit. With a weak global economy and low international commodity prices, export goods fell by 6.3% to USD 188.1bn. Imports, meanwhile, rose by 8.3% to USD 179.7bn as the country s fast-growing domestic economy shipped in foreign goods. It is important to note that a decreasing share of these imports are capital goods. Capital good imports in emerging markets are generally indicative of investment activity (gross fixed capital formation). This means that we may see a decline in the private sector investment component for Indonesian growth this year. The merchandise trade surplus in Q4 alone stood at only USD 591m, the lowest level since the mid-1980s, largely explaining the CA deficit of USD 7.8bn that was recorded in the same period. The deficits on the services and income components of the CA were broadly stable on an annual basis, at USD 10.8bn and USD 25.9bn respectively. Excluding changes in official reserves, the balance of payments remained in surplus by USD 165m, which is down from USD 11.9bn in 2011. The surplus on the capital and financial account rose to USD 24.9bn, compared with USD 13.6bn in the previous year. Net direct investment stood at USD 14.4bn, while net portfolio flows totaled USD 9.2bn. Other investments recorded a surplus of US$1.2bn, which is a reversal from the previous year's deficit of USD 1.8bn. As a result, Indonesia's stock of international reserves continued to rise, reaching USD 112.8bn at the end of 2012, sufficient to cover around six months of imports. Current and Capital Account Divergence 15000 10000 Current Account Capital Account 5000 0-5000 -10000 Source: Haver Copyright 2013 Cascade Asia Advisors. All Rights Reserved. Page 2
We expect a marginal improvement in Indonesia s merchandise export performance in 2013 and a recovery in the global economy in H2 2013. However, we also expect restrictive trade policies to remain in place on the exports of unprocessed minerals, which is one of the fundamental reasons behind the decline in exports in 2012. 2012 Growth What s Wrong with This Picture? We have been tracking Indonesian GDP for some time in past commentary, pointing specifically to Indonesia s trade balance as the biggest downside risk to growth. This was indeed a major drag on growth in Q4, shaving off 2.5 percentage points (pps). However, the interesting story comes from inventories, which added 3.1 pps. Given weak export growth, it is perhaps unsurprising that inventories were so strong. But why was so much produced in the first place? Contributions to Average Real GDP Growth by Expenditure Category (percentage points) Source: Indonesia Statistics Bureau In the eight quarters beginning with Q4 2009 and ending with Q3 2011, net exports accounted for about 1.4 pps of the average 6.3% y/y real growth rate. Since Q3 2011, net exports have caused a drag of about 1.2 pps on the same average growth rate. This is a very large swing of 2.6 pps, yet headline growth has been stable. So how has the economy made up those 2.6 pps lost to the net export swing? About 1.0 pp of additional growth is attributable to accelerating private consumption and investment, while government consumption has slowed, subtracting an average 0.2 pp. So that equates to a net 0.8 pp contribution, leaving 1.8 pps of missing expenditure growth. Copyright 2013 Cascade Asia Advisors. All Rights Reserved. Page 3
The national accounts made up the difference via inventories and the statistical discrepancy, which combined have seen a net swing of 1.8 pps between the positive net export period (Q4 2009-Q3 2011) and the negative (Q4 2011-Q4 2012). In Q4, these two series accounted for two-thirds of the real growth rate of 6.1% on the expenditure side, the largest positive contribution since Q3 2006. What does this tell us? We believe the large unexplained gap between production and expenditure, captured by inventories and the discrepancy, suggests production is still running ahead of demand, which we would expect to pull output growth. We have tentatively priced in a slow recovery of exports this year, which will help sustain growth at over 6%. But it is worth highlighting that perhaps domestic demand is not as robust as it appears at first glance. Without inventories and the discrepancy, final demand growth was only 5.1% y/y in Q4, the slowest in more than two years. Steady bonds, extended equity rally Buying flows were seen on the government bond market late last week but still in low volume despite the country s PMI dipping below 50 for the first time since its establishment a few months ago. However, bond prices ended steady at around current levels Thursday this week as a thick flow of offers capped the market since last auction and more supply of around USD 723mn hit the street, with the yield curve steepened and the 10y benchmark standing at 5,26%. Foreign bond holdings fell to USD 28.5bn as of 11 Feb from USD 28.7bn on 8 Feb. While the IDR consolidated against the USD within a narrow range below the 9,700 level, the JCI rallied further to 4,588.7 from 4,491.3 last Friday supported by USD 59mn of foreign influx. Onshore spot fixing will help smooth the USD/IDR exchange. Along with the decision by BI to hold the headline rate steady, the central bank will continue to maintain IDR stability by pushing to create an IDR spot reference rate. This is expected to boost liquidity and currency market efficiency, however, BI did not unveil further details on the upcoming spot fixing. What is the possibility of a rise in FASBI rate? A higher FASBI rate is needed to compliment the recent central bank s quantitative measures and FX market intervention in order to stem down pressures on the IDR. There are talks in the market of the possibility that BI will raise the FASBI (deposit facility) rate in Q1 at the end of February at the soonest to tweak domestic demand and increase the attractiveness of holding IDR assets. A 25 bps hike will send a signal that policymakers are ready to tighten monetary policy in response to any unexpected deterioration of Indonesia s external balance. Copyright 2013 Cascade Asia Advisors. All Rights Reserved. Page 4
Expect bond yields to remain low Volatility may bring down the government bond market, as foreigners still dominate bond ownership, while the IDR is still under pressure. With BI speeding up its plan to use government bonds as a monetary tool to replace the BI certificate (SBI), we expect yields to remain low and the 10y benchmark to trade around 5.2 5.5%. A barbell strategy is seen as an alternative to derive an optimum performance in 2013. Equities to lose steam soon? We have been witnessing the strength of real estate, banks, and consumer staples plays on the local bourse with earnings season scheduled for the week. The main driver is strong global inflows into equity, and particularly into emerging markets. EPFR global-tracked emerging market equity funds extended their current inflow streak to 21 weeks and over USD 65bn by early Feb, with diversified and China funds attracting the bulk of these inflows. There are signs, however, that the flows may have started to decelerate equity funds across the globe took in a net of USD 6.6bn in the week to February 6 th (vs. USD 1.2bn net inflows into bond funds), a significant slowdown compared to the net inflows of USD 18.7bn into equity funds globally in the week to January 30th. Apart from that, the market noted that MSCI announced the quarterly changes to its index on February 14 th (the changes will be traded on February 28th): 1) share increase for BBCA, BBRI, BBNI, BDMN, BMTR and MNCN; and 2) share decrease for JSMR. DISCLAIMER This document is for distribution only as may be permitted by law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject Cascade Asia Advisors to any registration or licensing requirement within such jurisdiction. It is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial instruments or to participate in any particular trading strategy. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document ( the Information ), except with respect to Information concerning Cascade Asia Advisors. The Information is not intended to be a complete statement or summary of the securities, markets or developments referred to in the document. Any opinions expressed in this document may change without notice and may differ or be contrary to opinions expressed by other business areas of Cascade Asia Advisors. Nothing in this document constitutes a representation that any investment strategy or recommendation is suitable or appropriate to an investor s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making investment decisions. Copyright 2013 Cascade Asia Advisors. All Rights Reserved. Page 5