Indonesia Macro Flash BI Remains on Hold; Appears More Dovish - Citigroup

 The BI rate was kept on hold — BI kept the policy rate at 6.75%, after core inflation stabilized in June (4.63%YoY) and the headline dropped to 5.54%YoY, from previously 5.98%. This is consistent with our expectation and consensus. In the monetary policy statement, BI revised up its economic growth expectation to 6.3% – 6.8% in 2011 and 6.4% - 6.9% in 2012. The midpoints for these forecasts are up by 30bps from their April forecasts.

 Despite better GDP growth expectations, there doesn’t appear to be added concerns over inflation — BI even sounded more optimistic in the monetary policy statement, stating that inflation could be “lower than expected” in the absence of administered price changes and smooth food supply distribution. BI expects a more balanced composition of economic growth going forward (with a growing role of investment). Indeed from 1Q11 GDP data, we saw that machinery investment has been picking up; and such trend may continue to result in noticeable capacity increases in a number of manufacturing-based industries. We expect this could eventually help to reduce Indonesia’s output gap.

 BI also maintained its relaxed language on currency appreciation — With the appreciation being still “in line” with regional trends, the impact on exports is still expected to be benign. Meanwhile foreign reserves increased further in June to
$119.7bn (6.8 months import and short term external debt cover) indicating a continued balance of payments (BOP) surplus. The BOP surplus appears to have eased though, as June experienced a reduction in SBI holdings by non-residents (as the statutory holding period was lengthened from one to six months).

 Although rate hike prospects seem more distant, we are still not ruling out the possibility of BI hiking by another 25bps this year — Oil prices have come down lately amid continued global growth uncertainties. However our estimate of the gap between the subsidized fuel price and its market price is still close to around 84% as of end June. We think that unexpected inflation stemming from subsidized fuel supply scarcities or uncoordinated rationing (in the event that the fuel sales quota is used up fast), still represents a risk worth looking out for towards the end of the year. As reported in 2011 mid-year budget revision discussions, the quota for subsidized fuel sales will likely be increased by only 5%.

 Market faced turbulence, but is likely due more to external factors — The BI rate decision was widely expected. However in mid-day trading, the rupiah weakened slightly against the dollar and the 10-yr bond yield increased by around 10bps from yesterday’s close to 7.36% amid deepening Eurozone concerns. In spite of this we continue to like the IDR and, with BI cognizant of core inflation pressures, we believe BI will continue to be tolerant of further IDR appreciation. We expect the IDR to trade in the range of 8,400 to 8,500 in the coming months.