Citigroup Indonesia Macro View - Trip Takeaways – BI Changes Course

 We now expect BI will hike 25bps in February; BI’s stance has changed — We changed our call last Friday and now believe BI may hike earlier in February instead of waiting until March. Our recent meetings in Jakarta with BI indicate a far more hawkish stance. We believe BI is increasingly concerned about the persistence of high headline inflation and that it sent a wrong signal to the market that it is targeting “core” instead of “headline”. We also think BI is taking cues from the sharp sell off in the bond market, and the hikes/increasing hawkishness of neighboring central banks, to move forward its rate hike.

 Headline inflation expected to remain elevated; Core more subdued — Risks from headline inflation are still largely from food (unusually prolonged wet weather), coupled with fertilizer price hike and higher energy prices, especially amidst the planned shift to unsubsidized fuel for private cars. BI now expects headline inflation (by year-end) will reach the high end of its forecast (closer to 6.1-6.6%). It sees less imminent risks to core inflation, though it also expects core inflation to reach about 5% by year-end.

 Investment outlook still encouraging, although infrastructure still slow — BI is forecasting investment (ex-inventory) to grow about 8.5% in 2010 and gain momentum to 10.6% in 2011F and 12.3% in 2012F. The upturn in investment also coincides with positive signals on FDI trends, although we think the US$12bn+ FDI figures BI cited as realized in 2010 appear to be gross, not net FDI figures. Progress on infrastructure still looks very slow given regulatory constraints and slow disbursal of public funds.

 Govt has fiscal space to absorb higher subsidies bill for now — The MOF estimates that a US$10/bbl increase beyond its oil price assumption raises the deficit by only c.Rp7trn (0.1% of GDP), and can be covered by contingency funds and using some financing surplus from 2010. Any cuts in bond issuance on the back of financing surplus may wait till mid-year budget revisions.

 Bond stabilization, in its current form, unlikely to inspire confidence — We understand the MoU that sets the stage for SOEs to buy govt bonds will be on “voluntary” basis, the size is unclear, and we think triggers for a buyback will likely be very stringent. We understand the recent market sell off hasn’t even reached the first “alert” stage of government ”crisis management protocol”.

 Post trip market implications — A 25bps rate hike could help allay concerns somewhat that BI is falling behind the curve on inflation, and should be positive for the long-end of the curve and possibly anchor IDR. However, recent events in Egypt spilling over to EM risk appetite/oil price concerns somewhat cloud the outlook. We expect the Indonesia bond curve to continue to bear flatten.