Economy The government is considering postponing the plan to limit the use of subsidised fuels - DBS Vickers

Inflation and trade data (Tue) and monetary policy meeting (Fri) will be the focus this week. The consensus expects CPI inflation to rise only slightly to 7.1% y-o-y in Feb from 7.0% in Jan, and the m-o-m growth in CPI to ease to 0.4% from 0.9%. It is reasonable to expect the m-o-m CPI growth in February will be lower than that in January judging from historical patterns of the seasonal factors, although this does not mean hat inflation is easing on a seasonally adjusted basis. Food prices will still be the major force driving inflation in Feb. Global food prices have continued to rise in Feb, reducing the effectiveness of the government’s price stabilisation measures of suspending food import duties.

Amid widespread inflation worries, Bank Indonesia was obliged to hike rates by 25bpsto 6.75% in February. Market opinion is divided about whether BI will continue to raise rates this month. We expect no rate change. We have been expecting BI to hike rates by 25bps in 1Q (which materialised in Feb), and then accelerate tightening in 2Q (+75bps to 7.5%) after the fuel price reform is implemented in March/April (banning the use of subsidised fuels for private cars in Jakarta ). However, last week the Chief Economics Minister said that the government is considering postponing the fuel price reform to avoid adding inflation pressure amid the surge in global oil prices. This will definitely alter our forecast of the inflation trajectory from 2Q onwards – inflation will rise more slowly than expected, giving room for BI to increase rates more gradually than our current forecast.

The government still has fiscal scope to maintain fuel subsidies and absorb the cost of oil price increases. While the subsidy burdens are growing, the government’s tax and non-tax revenues from commodity production and trade have been given a boost. We reckon that every 10% rise in oil prices (in IDR terms) will only cut the fiscal balance to GDP ratio by a marginal 0.1-0.2ppt (pleases see “ID: the 2011 budget preview, Nov 1, 2010). The Finance Minister estimates that a delay of the fuel price reform to 2012 will cost the government IDR 3-6trn (0.04-0.08% of GDP). The fact is that the government’s fiscal management has been persistently prudent. Last year the central government’s deficit was merely 0.6% of GDP, much better than the budget deficit of2.1%; public debt to GDP ratio slipped further by 2ppt to 26%.

On the external front, exports have been soaring since 4Q10 thanks to the commodity boom, and will likely post strong growth of 30% y-o-y in Jan11. Trade surplus is likely to remain supported at USD 2-3bn. Foreign investments in Indonesia ’s equity and bond assets have also rebounded after BI’s rate hike in February. Foreign investors bought IDR 3.5trn (net) in the Jakarta stock market during Feb 1-25th, while foreign holdings in Indonesian government bonds rose IDR 6.4trn in the same period. According to BI officials, foreign reserves have increased further by about USD 3bn this month to reach a new high of USD 98bn as of Feb 23.

The persistent strength in Indonesia ’s fiscal position and the improvement in external position are acknowledged by rating agencies. Last week Fitch revised Indonesia ’s sovereign rating outlook to positive from stable, increasing the likelihood that an upgrade to the investment grade will materialise this or next year. According to Fitch, faster reforms to tackle the low tax take, infrastructure deficiencies and corruption will support a rating upgrade, while an inflation shock would weaken the case for positive rating.