Indonesia Assets Should Continue to Hold Up Well

Indonesia continues to be buffeted by generally negative sentiment on EM. As we highlighted in a September report, the fundamental outlook for the nation is not so bad. As such, we expect Indonesian assets to continue generally performing along with wider EM.

POLITICAL OUTLOOK

President Jokowi took office in 2014 with high hopes for structural reforms. He won with 53.2% of the vote. Earlier that year, his party (PDI-P) won the most seats (109) in the 560-seat lower house with 19% of the vote. The next elections will be held in 2019, and will be held simultaneously for the first time ever.

After quick and early action on cutting fuel subsidies, he has run into congressional opposition and has had little subsequent success in passing structural reforms. He reshuffled his cabinet in August, in the hopes of jump-starting the process but to little avail so far. Jokowi is being hampered by the fact that his coalition only holds 207 seats, while the opposition holds 353 seats.

 

ECONOMIC OUTLOOK

GDP rose 4.7% y/y in Q3, about the same as in Q1 and Q2. For the entire year, 5% growth seems likely. This is close to 2014, but growth has steadily decelerated since 6.4% in 2010. Jokowi is hoping that planned infrastructure spending will help boost growth in the coming quarters.

Slower growth should pressure the budget deficit, but this has been offset a bit by falling subsidy costs. The budget gap is seen hovering around -2% of GDP this year and next, and is about the same as in 2014 too. Indonesia appears correctly rated for the most part by the agencies. Our own sovereign rating model has it at BBB-/Baa3/BBB-. Moody’s and Fitch line up with us, but S&P’s BB+ appears too low.

The external accounts have improved, however, as plunging exports have been offset by weaker import demand. The current account gap is expected to narrow to near -2% of GDP this year and next from -3.1 in 2014 and the recent peak of -3.3% in 2013. Foreign reserves have been falling steadily, however, and are poised to fall below $100 bln for the first time since December 2013.

CPI rose 6.2% y/y in October, the lowest since November 2014. This is still above the 3-5% target range but well below the cycle peak of 8.4% y/y from last December. Disinflation should continue, though a weaker rupiah will likely lead to some pass-through into inflation ahead.

Bank Indonesia just left rates steady at 7.5%, as expected. However, with inflation easing a bit and the rupiah fairly steady, it took the opportunity to cut reserve requirements by 50 bp to 7.5%. BI has taken other macro prudential measures this year to help boost lending. If disinflation continues, we think outright rate cuts in 2016 will be considered. Much will depend on how IDR fares.

 

INVESTMENT OUTLOOK

The rupiah is one of the better performers in EM, -10% YTD against the dollar. This compares to -30% for BRL, -24% for COP, -20% for MYR, and -19% for both TRY and ZAR. After the current period of stability, however, we think USD/IDR is likely to test the cycle high near 14828 from late September. Our EM FX model shows the rupiah to have WEAK fundamentals in EM, though slightly improved from VERY WEAK the previous quarter.

Indonesian equities are performing right along with wider EM. MSCI Indonesia is down -13.7% YTD, and compares to -14.1% YTD for MSCI EM. Our EM Equity model has Indonesia at a VERY UNDERWEIGHT position, down from UNDERWEIGHT the previous quarter. Foreign investors are net sellers of equities YTD, at -$1.4 bln.

Indonesian bonds have underperformed this year. The yield on 10-year local currency government bonds is up 82 bp YTD. This is in the underperforming camp, and is right behind the worst performing group that includes Brazil (+308 bp), Turkey (+191 bp), Peru (+172 bp), and Colombia (+120 bp). With inflation likely to fall, allowing the central bank to resume rate cuts, we think Indonesian bonds could start outperforming.