IDR: ‘middle of the way’ currency, but good prospect for carry-oriented trade

As President Widodo promised, he announced a 30% increase in subsidized fuel prices last night, generating excitement in the markets and an emergency central bank meeting. Despite the good news though, we see limited upside from Indonesia’s elections.

The big news from EM Asia overnight was that Indonesia’s government finally raised its subsidized fuel price. Although it was mostly expected, markets reacted positively. As promised, President Widodo (a.k.a Jakowi) delivered a 30% increase, which will greatly help offset the fiscal costs coming from the subsidy. This is obviously positive news for Indonesia, especially if the money saved gets reinvested in infrastructure, health and education, as Widodo had pledged. The move was also immediately praised by sovereign rating agencies.

The price of subsidized fuel was pushed up by 30%.  Gasoline was increased to 8,500 rupiah a liter from 6,500 rupiah, and diesel has been raised to 7,500 rupiah a liter from 5,500 rupiah. The move should save the public coffers around $8 bln, from the $23 bln subsidy bill.

In reaction to the news, the central bank announced an emergency meeting scheduled for today, when it hiked rates by 25 bp to 7.75%. However, the bank left the overnight deposit facility (FASBI) unchanged at 5.75%. Without the FASBI increase, we think the move should be interpreted more as a signal than actual tightening – which makes sense as a preemptive move. The central bank forecasts that inflation could rise to as high as 8% after the fuel shock and its knock-on effects are accounted for. For 2015, however, the bank sees the rate dropping to somewhere between 3-5%.

Despite the good news, we see the upside from the Indonesian elections as far more limited than, for example, the election of Modi in India. Note that the president did not need parliamentary approval. So the move is not indicative of a break in the unfavorable position Jakowi faces in parliament. The opposition controls nearly 60% of the seats in the newly elected House of Representatives (the main legislative body), inaugurated on October 1. In fact, even before he took power, the opposition seemed less than constructive by passing several unfavorable legislations. The opposition formed what is known as the Red and White coalition, which should continue to exert significant control over the parliamentary agenda.

On the positive side, Indonesia’ current account deficit is improving (about -2.9% of GDP) and the rupiah is close to its multi-year highs. As such, we see some scope for gains, especially as GDP is still running at a healthy 5% y/y and 3% y/y in Q3. While higher fuel prices will have a dampening effect, the more pragmatic and business friendly administration of Jakowi should help make up for it. Equity inflows have remained healthy this year ($4.2 bln), far exceeding those of the last several years, and bond inflows remain stable ($22 bln).

We view IDR as a ‘middle of the way’ currency in Asia. Although we don’t see scope for large gains, the elevated interest rates, combined with limited downside risks, makes it a good prospect for a carry-oriented trade.