Banking Update - Gauging inflationary risk - Bahana

Taking tight measures
Bank Indonesia (BI) has continued to closely monitor inflationary risk through both fiscal and monetary measures.

§ It is interesting to note that foreign inflows at the end of March 2011 caused 24.1% y-y hike in government papers to IDR1,106t with foreign ownership in SBI and government bonds having grown 50.0% y-y to IDR293t, 32.4% of total. Since its introduction last August, BI’s term deposits have been holding up well remaining above IDR200t in 1Q11, although it had trended down since January. In order to prevent sudden foreign reversals in liquidity, BI has tried to manage short-term capital flows by extending the minimum holding period in SBI to 6 months, effective May 13, from one month previously. Moreover, BI has ceased and replaced 1M, 3M and 6M SBIs with non-tradable Term Deposits.

§ March’s deflation of 0.33% m-m, which brought inflation to 6.7% y-y and 0.7% ytd, has paved the way for BI to maintain its benchmark rate, unchanged at 6.75% since its last 25bps increase on 4 February 2011. However, we expect inflation to rise again mid year, leading to another 25bp hike in BI rate, particularly given that core inflation has been trending up (exhibit 6). Note that the historical spread between the benchmark rate and core inflation averaged 2.1% in the past 5 years.

§ Additionally, BI’s strategy to let the IDR appreciate would also help lower imported inflation in hope of offsetting inflationary pressure from higher administrative prices (i.e. oil, which has jumped 59.3% since its low USD68/bbl in May 2010). Note that the IDR/USD has traded below IDR9,000/1USD in the past 77 days, the longest in 6 years.

Outlook: Cautiously optimistic growth
Judging from the recent progress, we are comfortable with how BI has managed inflationary risk. However, overhang remains on continued possible government’s policy to lift oil subsidy, particularly if oil price were to head above the USD120-130/bbl level. Hence, most banks have been cautiously optimistic in expanding their loan portfolios. On the demand side, total undisbursed loans have continued to increase reaching IDR587t, 32.5% of total loans, rather high when compared to historical average of between 24-27%.

Potential re-rating on lower risk free rate
Recent market outperformances (exhibit 5) have brought most banking share prices close to our target prices, leading us to downgrade ratings on most banks under our coverage to HOLDS. Hence, our NEUTRAL rating on the sector. However, it is worth noting that the downtrend in the Government’s 10 year bonds, which is used for our risk free rate base might further trigger upside potentials in our banking valuations. For now, our top pick in the sector remains with BBNI