Indonesia Macro Flash - BI on Hold, but Extends SBI Holding Period to 6 Months - Citigroup

Rates were kept on hold, as expected… — BI kept the policy rate at 6.75%, in line with our view and consensus, and also decided to extend the SBI holding period to 6 months (prev: 1 month) effective 13 May. We do not think the measure is retroactive for those who bought SBIs before this date, but it is not yet entirely clear.

…after inflation continued to fall in Mar — BI noted that headline inflation was exhibiting a declining trend (Mar: 6.65%YoY, Feb: 6.84%) but cautioned that inflation
risks remained high. Core inflation continued to climb to 4.45%YoY in Mar (Feb: 4.36%) on pass through from food inflation and rising inflation expectations. Going
forward, inflation pressures are expected to remain high due to high commodity prices, robust domestic demand, and high inflation expectations.

Global economic recovery to support exports; FX reserves reach new heights — BI expects 2Q11 economic growth of 6.4%YoY (2011: 6.0-6.5%, 2012: 6.1-6.6%). FX reserves hit a record US$105.7bn as of end-Mar, equivalent to 6.3 months of
imports and official debt repayments (3-Mar: US$101.8bn, 6.2 months).

BI to continue using IDR to reduce inflation pressures — BI views IDR appreciation as effective in controlling imported inflation from rising commodity prices and believes IDR appreciation has so far not dented export competitiveness. However, we see the recent measure on SBIs highlighting the desire to dissuade too much speculative capital inflows that could be a source of volatility later on.

What’s next for rate hikes? BI noted in its statement that there was still room to adjust the BI rate to absorb inflation pressures going forward. However, greater tolerance of IDR appreciation, delay in fuel subsidy reforms and bias to boost bank lending have likely pushed back BI’s timetable for rate hikes. BI Governor Nasution
earlier mentioned that the March harvest will keep inflation at “comfortable levels” in April and May, though we think rising core would still prompt 2 more hikes this year – possibly 25bps in June and one more in 3Q.

Market reaction muted but could see IDR weaken temporarily on repatriation flow — While the BI rate decision was expected, the extension of the SBI holding period was not, and resulted in the yield curve steepening as investors switched out of SBIs into the short end bond curve. We expect the new regulation to be positive for
front-end recaps and cause forward points of the NDF curve to fall further. The new
measure will likely be short-term negative for the IDR given the large number of offshore holdings of SBIs (Rp77.4trb as of end-March) which we think they can only
partially roll over to other IDR instruments given limited supply. However, given the underlying positive fundamental drivers of IDR, and BI's ability to cap volatility given significant FX reserves, we expect weakness to be temporary and could see USDIDR drift back to the 8,600 range in the coming months.