Global Economics & Markets Research Email: GlobalEcoMktResearch@uobgroup.com URL: www.uob.com.sg/research Macro Note Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 Enrico Tanuwidjaja Economist EnricoTanuwidjaja@uob.co.id The Fed is set for its final rate hike in 17 next month (implied probability as of today at 9.3% based on Fed Fund Futures). However, the bigger question is: how many more hikes in 18? UOB carries the view that the US Fed will deliver another 3x5bps rate hikes in 18, bringing the Fed Funds rate range to.-.5% by the end of next year. Emerging markets would brace for some extent of capital outflows amidst not just the betterlooking US economy but also on the basis of narrowing yield differentials between US yields and the associated EM yields. Those with stronger macro-fundamentals and more resilient macro-financial linkages would tend to better cushion the destabilizing risks of capital reversals. The Indonesian economy has seen a much stronger macro-fundamentals especially in external position with FX reserves had reached a record high of close to USD13bn (Figure 1) in September (October level at USD16.5bn) while exports growth has consistently been on the rise (Figure ). The current account deficit has narrowed from a recent high of -.3% of GDP in Q-1 to just -1.7% in Q3-17. For the whole of 17, we forecast CAD at -1.8% of GDP (year-to-date average is at -1.5%) and for it to widen slightly to -.% amidst the ongoing infrastructure spending and a likely recovery in domestic private consumption. FDI has also been edging much higher on a year-to-date basis (see Flash Note: Indonesia: Investment Realization Continue To Grow In Q3 17) and may continue to lend support towards Indonesia s external position. Figure 1. FX Reserves Reached Record High This Year Source: BI, UOB Global Economics & Markets Research 1 13 1 11 1 9 8 7 13 Taper Tantrum Renminbi parity re-centering 6 Jan 1 Feb 11 Mar 1 Apr 13 May 1 Jun 15 Jul 16 Aug 17 To better say it, the basic balance of Indonesia s external position, which is the sum of net FDI position and the CAD has for the first time turned into a +1.5% of GDP since at least the past 5-6 years (see Figure 3). Although Indonesia has structurally remains at the bottom amongst the neighboring Asian countries, but an improving trend may render a better perception that policy measures have worked its way to increase the resiliency of Indonesia s external balance. This has and will continue to bode well for the stability of the exchange rate. Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 1 Page
Figure. Exports Has Consistently Recover Source: Central Statistical Bureau, UOB Global Economics & Markets Research %-yoy 6 5 3 1-1 - -3 - Jan 1 Jun 1 Nov 1 Apr 15 Sep 15 Feb 16 Jul 16 Dec 16 May 17 Oct 17 Exports Imports Ex-6mma Im-6mma Figure 3. Basic Balance (Net FDI+CAD as % of GDP) Has Now Turned Slight Positive % of GDP. -q-mma 1% 1% 1% 8% 6% % % % -% -% Q '1 Q '13 Q '13 Q '1 Q '1 Q '15 Q '15 Q '16 Q '16 Q '17 China Koera Malaysia Philippines VN Thailand Indonesia As for the macro-financial linkages, the monetary policy has seen bps rate cuts delivered by Bank Indonesia (BI) since 16 to-date while changing the benchmark policy rate closer to the international best practice to the short end of the money market curve in the form of BI 7-day reverse repo. Slowing inflationary pressures and risks of sluggish private consumption (consequently pulling the GDP growth lower see Flash Note: Indonesia: Q3 GDP Growth Accelerated Tad Higher) has allowed BI room to ease (Figure ) and thus giving support to Figure. BI Rate and Inflation 9. 8. 7. 6. 5.. 3.. Jan-1 May-1 Sep-1 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 CPI (% YoY) BI Policy Rate (%) Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 Page
the economy, despite now probably has reached the floor limit given advanced economies monetary tightening ahead. Indonesia continues to provide investors with positive total return on a year-to-date basis with a relatively stable rupiah on the back of improvement in the country s external balance (Figure 5-7). Figure 5. Total IDR Return (% year-to-date) Source: Bloomberg, UOB Global Economics & Markets Research % Total Return HKD. PHP 1.7 JPY 3.7 IDR 5. SGD 7.5 TWD 7.8 CNY 9. CNH 9. INR 1. THB 1.5 KRW 1.8 MYR 11.5... 6. 8. 1. 1. 1. Figure 6. Spot IDR Return (% year-to-date) % Spot Return PHP HKD IDR JPY INR CNY CNH SGD TWD MYR THB KRW -. -.7 -.5 3.8..6.9 6.6 7. 8.1 9. 9.9 -. -.... 6. 8. 1. 1. Figure 7. Interest Return (% year-to-date) % Interest Return JPY TWD HKD KRW SGD THB MYR CNH PHP CNY INR IDR -.1.6.7.8.9 1. 3.1 3.9.. 5.8 5.8-1.. 1.. 3.. 5. 6. 7. Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 3 Page
Asset Markets Continue To Rally Risks of Capital Reversal Imminent? Given the backdrop of robust macro-fundamentals and sound macro-financial linkages, both the equity and bond markets have shown consistent positive performance throughout this year despite occasional hiccups in the external development (Figure 8). The acknowledgement of ratings upgrade by the S&P in May 17 also has opened doors for new set of investors to have some exposure towards Indonesian markets and asset classes, pouring inflows into the country s capital markets. Figure 8. Indonesian Asset Markets Performance 9.5 9. 8.5 Brexit Trump won US Election S&P Upgrade 6,5 6, 8. 5,5 7.5 5, 7. 6.5,5 6. Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 Apr 17 Jun 17 Aug 17 Oct 17 IDR Gov 1Y (%, LHS) Jakarta Stock Index, With noticeably significant portfolio inflows into the shore, what are the risks of reversal from the Indonesian markets? From our view, risks are manageable. But, Figure 9 suggests that Indonesia has a relatively large foreign holding of its outstanding tradable government securities and may pose biggest risks of outflow if there is faster rate hike expectation from the US or unexpectedly tighter advanced economies monetary policies. Already, the net foreign selling in Indonesian equity markets have erased all the inflows seen in the early part of the year, putting all equity flows back to a slightly net negative position (Figure 1). Nevertheless, the JCI index still reached record high as evident in Figure 8 above, perhaps indicating that the herding behavior from domestic have somewhat receded and they have been buying some local stocks. Figure 9. Foreign Holdings of Indonesian Sovereigns Source: Bloomberg, Ministry of Finance, UOB Global Economics & Markets Research 5 35 3 5 Foreign Holdings of Indonesian Government Securities, in % of total outstanding 15 1 5 Oct-5 Oct-7 Oct-9 Oct-11 Oct-13 Oct-15 Oct-17 Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 P a g e
Figure 1. Net Cumulative Foreign Flows on Indonesian Stocks Source: Bloomberg, IDX, UOB Global Economics & Markets Research.5. 1.5 1..5. -.5-1. -1.5 -. -.5 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Looking at portfolio capital inflows into Emerging Asia (countries included here are China, India, Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand), it seems to suggest that most of the portfolio inflows are mainly dominated by the bond flows (Figure 11). Flows are relatively driven by Chinese capital flows, noticeably outflows since 15. Nevertheless, despite Indonesia seems to follow suit in the roller coaster ride of capital flows in both the bond and equity markets, the inflows into the bond market look stickier (Figure Figure 11. Annual Portfolio Flows Into Selected EM Asia Region () By Broad Asset Class 5 15 1 5 1 11 1 13 1 15 16 17 Bonds - EM Asia Equity - EM Asia Figure 1. Annual Total Portfolio Flows Into Selected EM Asia Region vs. Indonesia () 15 1 5 1 11 1 13 1 15 16 17 Total - EM Asia Total - Indonesia Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 5 P a g e
1-15) compared to the stock market (more sentiment-driven to some extent). This is likely to be supported by not just better macro-external management and reasonably prudent fiscal policies, but also by the fact that Indonesia has been keeping its external debt from ballooning. In fact, amongst the G economies, Indonesia has the lowest external debt over GDP ratio at 68% as of 16 based on the Bank for International Settlement (BIS) data (Figure 16). Figure 13. Annual Bond Portfolio Flows Into Selected EM Asia Region vs. Indonesia () 1 1 8 6 1 11 1 13 1 15 16 17 Bonds - EM Asia Bonds - Indonesia Figure 1. Annual Equity Portfolio Flows Into Selected EM Asia Region vs. Indonesia () 1 1 8 6-1 11 1 13 1 15 16 17 Equity - EM Asia Equity - Indonesia Figure 15. Portfolio Capital Inflows in 17 is Above Average 18 16 1 1 1 8 6 - - 1 11 1 13 1 15 16 17 Total - Indonesia Equity - Indonesia Bonds - Indonesia Average Total Portfolio Inflows Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 6 P a g e
Figure 16. Indonesia s External Debt Lowest Amongst G Countries 16 data Source: BIS, Bloomberg, UOB Global Economics & Markets Research 35 3 5 15 1 5 % of GDP JAPAN CANADA FRANCE BRITAIN ITALY EUROZONE CHINA UNITED STATES AUSTRALIA SOUTH KOREA GERMANY BRAZIL SOUTH AFRICA INDIA TURKEY RUSSIA MEXICO SAUDI ARABIA ARGENTINA INDONESIA We did some exercise to compare different global shock episodes in recent times to look at how capital flows have been behaving for Indonesia (Figure 17-). We found that equities outflows are longer before they turn into reflows back into Indonesian equity market as compared to bond outflows. Over time, it is also observed that investors do not take that long to put the portfolio flows back to Indonesia as soon as the shock event subsided. The following few notable episodic charts will describe what we meant by that. The way to read the scenario charts is basically to look at time t as the peak/exact stress episode while t- and t+ are week(s) after that exact stress period. For example, in the Fed s Bernanke Taper Tantrum episode, the event took place exactly at 3rd May 13 (time t ) and we trace how the funds behaved 6 months before and after. The observations go as follow for portfolio capital flows into Indonesia across different global shock scenarios: In 11 European debt crisis and also risk of Greece defaulting has resulted into outflows around weeks before the peak of the stress point and up to 7 weeks after before inflows started coming back (Figure 17). In 13 s famous taper tantrum, both equity and bond markets witnessed outflows up until 6 weeks after May 13 before investors start coming back to re-enter the Indonesian capital markets (Figure 18), even so the inflows are more dominant in the bond market as compared to the equity market. During August 15 s PBoC CNY parity adjustment, the inflows came back around 1 weeks after they announce the unprecedented policy in its exchange rate policy while the Indonesian equity market continue to saw outflows (Figure 19). In the first Fed rate hike of December 15, the reaction can be said to be rather mild as it is well anticipated by market participants. As a result, bond market saw outflows around half a month before that while equity market continue to witness inflows. Right after the rate hike, due to its dovish tone, both equity and Figure 17. European Debt Crisis/Greece Default Scenario 8 6 - - -6 t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 7 Page
bond markets continue to receive consistent inflows (Figure ). During Brexit in June 16, very limited outflows and only within short period of time before it started to come back while equity reflows was only brief before it was driven out again by other factors (Figure 1). Finally, the Trump s election victory in November last year saw brief 1 month outflows in both equity and bond markets before investors putting portfolio capital inflows back even bigger than before (Figure ). Figure 18. 13 Taper Tantrum Scenario 5 3 1-1 - -3 - -5 t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ Figure 19. 15 s PBoC CNY Parity Adjustment Scenario 3 1-1 - -3 t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ Figure. 15 s First Fed Rate Hike Scenario 7 6 5 3 1-1 - -3 t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ Indonesia: Portfolio Capital Flows Ahead Of Fed s 18 Rate Outlook Tuesday, 1 November 17 8 Page
Figure 1. 16 s Brexit Scenario 6. 5.. 3.. 1.. -1. -. t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ Figure. November 16 s Trump Election Victory Scenario 6 5 3 1-1 - t- t-1 t-18 t-15 t-1 t-9 t-6 t-3 t t+3 t+6 t+9 t+1 t+15 t+18 t+1 t+ We believe that if the Fed is going to deliver a somewhat dovish hike in the form of lower than expected rate hike expectations for 18, then it is likely we would not see tremendous risks of capital reversals, but the reverse is true. Regardless, whichever scenario that may happen, for Indonesia it is always desirable to maintain sound balance of monetary and fiscal policy mix, and coupled with stronger external position, Indonesia is in a better position to manage the potential capital outflows in 18. Our cautiously optimistic view for the Indonesian economy in 18 remains unchanged with GDP forecast at 5.3%; inflation at.%; CAD at -.% of GDP. On the rates front, we expect that by December 18, BI may tighten one time in the form of a 5bps rate hike to.5%. Finally, we keep our year-end IDR forecast at 13,8 for 18. Disclaimer: This analysis is based on information available to the public. Although the information contained herein is believed to be reliable, UOB Group makes no representation as to the accuracy or completeness. Also, opinions and predictions contained herein reflect our opinion as of date of the analysis and are subject to change without notice. UOB Group may have positions in, and may effect transactions in, currencies and financial products mentioned herein. Prior to entering into any proposed transaction, without reliance upon UOB Group or its affiliates, the reader should determine, the economic risks and merits, as well as the legal, tax and accounting characterizations and consequences, of the transaction and that the reader is able to assume these risks. This document and its contents are proprietary information and products of UOB Group and may not be reproduced or otherwise. Singapore Company Reg No. 19356Z