Deutsche Bank Indonesia strategy : BI sets the tone in the near term

BI sets the tone in the near term
Market behaviour following higher-than-expected January inflation was interesting and may provide some hope of a back-stop from the recent havoc -- provided BI follows with a 25bps rate hike on Friday (4 February). Contrary to expectations, the market actually gained 0.8% from its intra-day low following the news, but was "marked down" by "market on close" orders on some counters. The positive reaction seems to suggest that the market would be happy with – and indeed expects -- a simple rate hike response, perhaps 25bps come this Friday. Naturally, disappointment looks a given if BI decides otherwise.

Higher headline but lower core inflation
Foods (primary and processed) were again the main culprit, accounting for 75% of January inflation of 0.89%mom (December 0.92%). Indeed, 40% of the rise that pushed headline to 7.02% (December 6.96%) was due to four items: rice, onions and two types of chilli. Core inflation remained subdued at 4.18% (December 4.28%) because the calculation excludes the very items that caused headline to spike. We note a slight uptick in non-food inflation but at 3.9%yoy, based on our estimates, this still appears well contained.


Record trade surplus
Away from inflation, December external trade was very robust, with both exports and imports at all-time highs, as was the trade surplus, which clocked in at some US$3.7bn, double the monthly average last year. Overall, the FY10 trade surplus reached US$22.1bn. This contributes to the current account surplus of US$6.2bn (BI estimate), and consequently the increase in FX reserve by US$30bn vs. portfolio inflows of US$16bn (US$4bn equity and US$12bn bonds + SBI). Non-commodity exports also rose a significant 25%yoy (15% of non-oil). Nonetheless, commodity exports (non-oil) remain the primary driver, with the top seven items +40%yoy (c. 50% of non-oil). Exports to China, though the second-largest after Japan, were the biggest driver; they represented 16% of the increase in exports.

Sentiment rules
We reiterate our view that inflation is not going to spiral out of control, but a near-term market call has more to do with trying to tap into market psychology than assessing fundamentals. Indeed, we think the recent effects of rising inflation and a potential rate hike have a minimal impact on our earnings estimates. However,
because inflation has become a focus point elsewhere, unless inflation peaks -- likely in 2Q -- the market will likely remain fixated on the issue. As such, BI's actions this Friday are likely to set the market direction in the near term.