Deutsche Bank Strategy Alert : Key take away from meeting with BI

BI has explicitly stated that it will address the rising inflation. Whilst confident that CPI won't exceed 7%, it aims to bring it towards the 5% +/- 1% target range using a mix of 4 policy options;

1). BI explicitly mentioned a RATE HIKE, however the magnitude/timing is still being evaluated. It also noted that the economic dynamics are such that the Taylor rule on the right interest rates per inflation is outdated; reading between the lines, we believe the rate hike won't be too drastic.

Indeed many have often cited the negative real rates, but in fact, no-one gets to borrow at policy rate, ave. lending rates of around 12% are well above inflation.

2). Allow further CURRENCY APPRECIATION. As 60% of Indo's exports are commodity products, the impact on competition is limited. Besides, margins for the main commodity exporters are hefty enough to weather some appreciation.

3). RR MEASURE: This has recently been instituted at 8% for Rp deposits, and for FX in March. Liquidity supply in the system is ample even considering the unevenness across different banks. In fact, BI still expects FY11 system loan growth of 24%.

4). Manage CAPITAL FLOW closely. It had scraped 1mth SBI, and instituted 1mth holding period for 3mth and 6mth paper. This will be under constant review going forward.

On the fuel subsidy removal; BI's estimates of impact to CPI: 1st phase (Apr-11) +0.15% (slightly higher than our est. of 0.13%) - 2nd phase (Jul-11) +0.32%, in line with our est.

On the whole, the message is a bit more reassuring. Although still uncertain, we think there is more than a fair chance of BI hiking by 25bps on 4 Feb. This may help arrest the market downside, but for the market to really move further, we need to see inflation coming off.

It might peak in 2Q11 and come off in 2H11; as 3/4 of FY10 inflation was in 2H10.

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