OREANDA-NEWS. Official data released on 5 February, showed Indonesia's economy expanding at its slowest pace for five years in 2014. Weak commodities prices affected the country’s exports, putting pressure on the country's new president to deliver promised reforms

On the positive side, Indonesia attracted 79 trillion rupiah (US\$6 billion) of direct foreign investment commitments last quarter, 0.5% more than the previous quarter. For the entire 2014, Indonesia received foreign investment commitments of 307 trillion rupiah, 13.5% increase from 2013.

Earlier, Bank Indonesia decided to hold interest rates steady at 7.75% at a policy meeting. The move, while helping to keep the lid on inflation also demonstrated that the bank does not anticipate further inflationary pressure. Indonesia’s key inflation had accelerated to 8.36% year-on-year in December. November’s Consumer Price Index (CPI) recorded 6.23% in November and 4.53% in the preceding month.

Indonesia Steadies Rate

The sudden rise in inflation rate stemmed from President Joko Widodo's mid-November decision to hike fuel prices by more than 30% as part of the reform process, which spurred Bank of Indonesia to raise the benchmark interest rate 25 basis points to 7.75%.

Plunging oil prices allowed Widodo a chance to reform Indonesia's costly fuel subsidies, removing them for gasoline and capping the one for diesel at a fixed amount.

Indonesia’s CPI and Key Interest Rate

Source: Bloomberg

The Indonesia central bank stated its intention to roll back inflation towards its target of 3% to 5% in 2015. This has been viewed as the central bank’s preference to safeguard long term financial stability. During the past four years, inflation had only ended up above key interest rate twice in 2010 and 2013, only to fall below the key interest rate soon after.

With the winds of deflationary pressures blowing straight into the face of the world, it is highly unlikely that Indonesia faces much risk from imported inflation. Hence, inflation risks could recede in coming months. Traditionally, central banks have favoured price stability, maintaining that it is a pre-requisite for sustained long-term growth.

Bank Indonesia forecasted stronger economic growth in 2015 to be in the 5.4% to 5.8% range and expects an improvement in the current account deficit due to low oil prices. The World Bank, however, presented a more cautious picture, anticipating a growth pick up from 5.1% in 2014 to 5.2% in 2015 and 5.5% for 2016, much lower than Widodo's target of 5.8% for 2015.

Manufacturing Stabilises

Indonesia's manufacturing activity shrank for the fourth straight month in January but at a slower pace.

The HSBC Markit Purchasing Managers' Index (PMI) increased slightly to 48.5 in January from 47.6 in December, possibly reflecting the beginnings of a rebound in the manufacturing sector. Coupled with the stabilisation of oil prices, Indonesia’s economy may yet exceed forecasts.

Indonesia’s HSBC Markit PMI

Source: Bloomberg

President Joko Widodo is confident of hitting the economic target numbers. “We are confident to have the target of our economic growth” of 5.7% this year, the president said in a Feb 2 interview in Jakarta. “But we must increase our exports volume and we must reform our bureaucracy. We must invite (foreign direct investment),” he stated in an interview.

The Indonesian economy’s potential is restrained by years of under-investment in infrastructure, plunging commodity prices and the withdrawal of US monetary stimulus. The president is hoping to turn the economy around by fast-tracking large infrastructure projects and cutting red tape. Other measures proposed include crafting one set of legal maps that detail land ownership, a move that will speed up project approvals and property acquisition.

Arrows at Widodo’s Disposal

The fuel subsidies cut implemented in January is estimated to shave off nearly US\$20 billion in spending for the government. This gives the Indonesian government room to implement some of the large scale infrastructure projects.

Energy subsidies have often accounted for a fifth of total government spending, more than spending on welfare and infrastructure programmes combined. The benefits, however, are not evenly distributed, favouring the middle-class more than the poor.

Further, the projected easing of inflation will give the central bank room to cut interest rate and implement monetary easing. As could be seen in the table below, Indonesia has the highest rate among ASEAN countries, so as to maintain the strength of the Rupiah and keep a lid on inflation.

Interest rate of ASEAN Countries

Countries %
Indonesia 7.75%
Malaysia 3.25%
Philippines 4.00%
Singapore 0.08%
Thailand 2.00%

Source: Bloomberg, 4 February 2015

Indonesia posted a trade surplus of US\$187 million in December, exceeding estimates by a Bloomberg survey of analysts. In 2014, Indonesia recorded a US\$1.88 billion trade deficit, a strong improvement from the US\$\$4.08 billion deficit in 2013. The trade deficit is forecasted to continue to improve in 2015 thereby relieving pressures on the exchange rate and the economy. A narrower current account deficit reduces vulnerability to capital outflows as a smaller deficit signals less reliance on foreign funding.

Appetite for emerging market assets, including Indonesian assets, rose as a result of the quantitative easing (QE) program announced by the European Central Bank.  This QE programme, which comes shortly after the US Federal Reserve ended theirs in late-2014, will increase global liquidity and is expected to see funds inflow into emerging assets as easy money seeks higher returns.

Yet on the other hand, the Federal Reserve is poised to raise US interest rates, which could cause capital outflows from Indonesia and other emerging nations. While the rupiah could come under selling pressure, the central bank should be able engineer a smooth landing. Presently, foreign reserves of the country stands at US\$105 billion, the highest since 2005.

Indonesia’s Foreign Reserves (US\$ billion)

Source: Bloomberg

Increase in Outstanding Positions in the SGX Indonesia Futures

Outstanding positions in the SGX MSCI Indonesia Index Futures grew 8% afrom the end of 2014 to the end of January, to US\$93 million which may be a reflection of the growing investor confidence in the long-term prospects of the Indonesian market. Total value of the SGX MSCI Indonesia Index Futures traded in January rose to US\$270 million, an 11% increase from December.

The most recent roll of the SGX MSCI Indonesia Index Futures from the January 2015 contract to the February 2015, reflected investors long-term view of the Indonesia market, with the vast majority of January positions re-establishing in the February 2015 contract. As of the last trading day (29 January 2015), 95.4% of January 2015 contracts rolled into February 2015 contracts (versus the one year historical average of 75.8%).

Active market makers provide on-screen liquidity throughout the day at 2-3 ticks (?20-30bps) and are able to respond to quotes (RFQ) to providing block liquidity. Refer below for the contact details of market makers available to provide block quotes.