Bank Indonesia holding its policy rate steady at 6.75% - CLSA

It was interesting to see that in spite of Bank Indonesia holding its policy rate steady at 6.75%, JCI rallied and more importantly the Rupiah continued to strengthen and now trading comfortably below 8,800.

Our economist Tony Nafte highlighted that Bank Indonesia’s policy stance has tightened. It was at pains to reassure the market that it will ‘adjust the BI rate in stages in a timely manner’.

Bank Indonesia’s reason for not hiking rates despite its acknowledged high inflation risk was that monetary policy has tightened via exchange rate appreciation. We applaud BI’s decision for a more flexible exchange rate but this will still need to be combined with higher interest rates for effective inflation control (see attached for details).

The wildcard here obviously remain to be oil price. While we think the economy will be able to shield a slowing rising oil price from FX appreciation and phasing out of fuel subsidies, a sudden big spike will be a different animal to deal with. 2008 experience tells us that inflation will also spike and consumer companies will not be able to raise prices enough to maintain margins.

IEA's oil market report in 2011 highlights that in 2010 the global oil burden approx 4.1% of GDP, second highest following a major recession since the 8% in 1980. Not too far from the 5.1% in 2008. On top of that, the current money and credit situation is very different now with trillions of new dollar printed (M2 alone has grown by $1tr) and seeing increasingly evidence that the credit cycle is picking up in the west. Now with the situation in the middle east, the trend is certainly supporting even higher oil price.

As a hedge to higher oil prices, I will be buying coal and plantation names (bio diesel again making a lot of sense). Bumi Resources (BUMI IJ) is seeing a bit of sell-on-news selling pressure post the Vallar transaction but the deleveraging and growth story remains very compelling. We also like Bukit Asam (PTBA IJ), Inidka (INDY IJ) and ITMG.