Macro Chart Pack: Feeling The Heat

BMI View: We have long warned of overheating pressures within Indonesia's economy and it is clear from the recent data flow that such pressures have started to boil over. The most obvious symptoms are a dwindling foreign reserve stock and rising inflationary pressures, and while we are not calling for a painful correction, we are likely to see a macro adjustment take place via further interest rate hikes and slower domestic demand momentum. We remain bearish towards the Indonesian rupiah which, despite its steady grind lower, remains significantly overvalued.

BMI has long warned of the overheating pressures percolating under the surface of Indonesia's economy. Back in September 2012, for instance, we cautioned that '...signs of overheating as a result of Bank Indonesia's easy monetary policy are beginning to emerge, a phenomenon that will begin to unwind as we move into 2013...' ( see 'Domestic Economy Resilient, But 2013 Slowdown Looms', September 12 2012). Fast forward to today and it is clear from the recent data flow that such pressures have started to boil over and are taking their toll on the country's macroeconomic health.

The two most visible pressures points are Indonesia's dwindling foreign reserve stock and rising inflationary pressures. Foreign reserves fell below the US$100bn mark in June (at US$98.1bn) for the first time in 28 months, meaning that the country's external buffer has now fallen 21.3% from its August 2011 peak. Meanwhile, headline consumer prices jumped 5.9% year-on-year (y-o-y) in June from 5.4% in the previous month, confirming the longer-term inflationary trend.

External Buffer Is Shrinking
Indonesia - Foreign Reserve Stock, US$bn & % chg y-o-y

BMI View: We have long warned of overheating pressures within Indonesia's economy and it is clear from the recent data flow that such pressures have started to boil over. The most obvious symptoms are a dwindling foreign reserve stock and rising inflationary pressures, and while we are not calling for a painful correction, we are likely to see a macro adjustment take place via further interest rate hikes and slower domestic demand momentum. We remain bearish towards the Indonesian rupiah which, despite its steady grind lower, remains significantly overvalued.

BMI has long warned of the overheating pressures percolating under the surface of Indonesia's economy. Back in September 2012, for instance, we cautioned that '...signs of overheating as a result of Bank Indonesia's easy monetary policy are beginning to emerge, a phenomenon that will begin to unwind as we move into 2013...' ( see 'Domestic Economy Resilient, But 2013 Slowdown Looms', September 12 2012). Fast forward to today and it is clear from the recent data flow that such pressures have started to boil over and are taking their toll on the country's macroeconomic health.

The two most visible pressures points are Indonesia's dwindling foreign reserve stock and rising inflationary pressures. Foreign reserves fell below the US$100bn mark in June (at US$98.1bn) for the first time in 28 months, meaning that the country's external buffer has now fallen 21.3% from its August 2011 peak. Meanwhile, headline consumer prices jumped 5.9% year-on-year (y-o-y) in June from 5.4% in the previous month, confirming the longer-term inflationary trend.

External Buffer Is Shrinking
Indonesia - Foreign Reserve Stock, US$bn & % chg y-o-y

Both these dynamics are likely to worsen in the near term, in our view. Despite a slight improvement to a US$590mn shortfall in May, Indonesia's cumulative trade deficit stood at US$2.5bn in the first five months of 2013 (from a surplus of US$1.8bn in the same period a year earlier). Absent a material improvement in the country's terms of trade - which looks unlikely to us given China's own macro woes - further monthly deficits should be expected in the months ahead. At a time when inflows into emerging markets such as Indonesia have started to dry up, further pressure on the country's external position looks to be on the cards. On the inflationary front, we expect headline price growth to continue accelerating now that Jakarta appears to be pushing ahead with cutting energy subsidies. Moreover, the temptation of expansionary fiscal policy in the run-up to next year's general elections will prove difficult to resist, which will in turn fan inflationary forces.

More Hikes To Come
Indonesia - Policy Rate, Government Bond Yields & Inflation, %

In terms of the macro implications, we believe that further interest rate hikes are only a matter a time, and that downside risks to our baseline growth outlook are increasing. Bank Indonesia (BI)'s task in trying to maintain currency stability and keeping a lid on inflation will ultimately prove unattainable, and we expect the central bank to follow through on June's 25 basis points (bps) of interest rate hikes with a further 50bps worth of front-loaded tightening by end-2013 (taking the benchmark rate to 6.50%). The major upside moves in short-end sovereign yields ( see chart) suggests that the bond market is in agreement with us. Meanwhile, currency weakness, rising borrowing costs and weaker overseas capital inflows will undermine Indonesia's domestic demand story in the near term. While our real GDP growth forecasts of 5.9% and 6.0% in 2013 and 2014, respectively, sit comfortably below consensus, the risks of a more significant adjustment in economic activity are very much on the rise.

Renewed Weakness Likely
Indonesia - Exchange Rate, IDR/US$ & RSI

We remain bearish towards the Indonesian rupiah which, despite its steady grind lower, remains significantly overvalued. While we have seen the semblance of stability at the IDR10,000/US$ level, it is difficult to look past further weakness in the near term given that the fundamentals of a weak terms of trade position and a reversal in portfolio inflows continue to point to depreciation. Moreover, despite being in a two-year bear market, the currency remains significantly overvalued on a real effective exchange rate basis, suggesting to us that further long-term adjustment remains in store.

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This article is tagged to:
Sector: Country Risk
Geography: Indonesia, Indonesia
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