Indonesia Macro Flash - BI Is Less Hawkish and Tolerant of Rupiah Appreciation - Citigroup

 Rates were kept on hold, as expected, but tone less hawkish – BI kept the policy rate at 6.75%, as widely expected, especially after April’s negative inflation surprise (-0.31% MoM), though BI still cautioned that “inflation risks going forward remained high”. Nonetheless, the policy statement looks less hawkish than the previous one, with BI saying it will “continue to strengthen the implementation of monetary and macroprudential policy mix, including through the liquidity management and interest rate response, to maintain macroeconomic stability and to keep inflation within targets.” This is more “mixed” policy language than what it explicitly said in April – “Looking forward, Bank Indonesia sees possibility to adjust the BI rate to curb any further rise in inflationary pressure.”
 BI reiterates its comfort with IDR appreciation to contain inflation – Similar to its April statement, BI says Rupiah appreciation is consistent with efforts to contain inflationary pressures, but BI also added that Rupiah appreciation “is still conducive to maintaining the momentum of growth”. It replicated last month’s statement saying that Rupiah appreciation “does not have negative impacts to maintaining competitiveness” and further cites that it expects sizeable BoP surplus in 2Q 2011 when it expects both the current and capital account to continue to remain in surplus. We recently argued that the 1Q 2011 BoP data with similar “twin surpluses” is also conducive to BI tolerating more IDR appreciation (see EM Daily – Asia Edition, Indonesia — 1Q11 BoP Surplus Narrows but Remains High at $7.7bn, which may bolster BI’s tolerance for IDR appreciation, 11 May 2011).
 We now think BI will only hike another 25bps this year – With this less hawkish policy statement and the similar signals we got from our recent Indonesia trip (see Indonesia Macro View – Trip Note: IDR as BI’s Disinflationary Tool, 10 May 2011), we now officially change our call. We think we will only get only one more 25bps hike this year, and the timing may be pushed back to 4Q 2011.
 2011 growth at upper end of 6.0-6.5%; FX reserves reach new highs – BI expects robust economic growth to continue into 2Q11 and now expects 2011 growth closer to the topside of its forecast of 6.0-6.5%. FX reserves set another record high of US$113.8bn as of end-Apr, equivalent to 6.7 months of imports and official debt repayments (end-Mar: US$105.7bn, 6.3 months), which reduce BI’s incentive to aggressively build up more precautionary FX reserves.
 Market reaction muted – The BI rate decision was expected and the bond market in fact softened slightly on weaker risk sentiment. We have turned more medium-term bullish on IDR and see it trading around 8,300-8,500 vis-à-vis the USD later this year. We think IDR bond yields can still bull-flatten further on offshore flows, solid country fundamentals and manageable near-term inflation outlook.