Indonesia 2017: As Good as it Gets
    Category: Outlook 2017 By : Harry Su Read : 1017 Date : Tuesday, November 08, 2016 - 13:58:49

    In 2017, President Joko “Jokowi” Widodo’s third year in office, we believe Indonesian equities, already the best performing in the region year-to-date, will rise further.  At this stage of the cycle, the country is entering a new low inflation regime, allowing for lower interest rates, a stronger rupiah, and a higher stock market—with a JCI target of 6,600. Inflation is a supply phenomenon with a volatile component taking part in determining inflation. Interestingly, average core inflation is declining, however, especially following low commodity prices and muted growth. Thus, Bank Indonesia has lowered its inflation target to 3.5% in 2018, allowing for a new low benchmark interest rate in 2017.

    To tackle inflation fluctuations, the government has put in price controls, especially for basic necessities such as cooking oil and beef. In the last two years, core inflation had a strong correlation with the rupiah, with a stronger rupiah causing lower core inflation. Historically, fuel prices are the number one factor for inflation. Our analysis finds that every 10% fuel price increase adds 0.7% month-on-month higher inflation. That said, recent low oil prices in rupiah terms mean manageable, lower inflation.

    With no fuel-price shock in 2016, coupled with weaker demand, 2016 inflation should be 3.3%, near historical low levels, and advancing to 3.8% in 2017 with economic recovery. On the monetary side, there can be further rate cuts, in line with Bank Indonesia’s decision to pursue easing since early 2016. Therefore, there’s room for further cuts, particularly as real rate differentials remains wide between Indonesia and the U.S.

    In fact, the situation now is similar to 2012, with inflation below 4%, and the 10-year U.S. treasury at 1.7%, below forecasts of 2%. Hence, Bank Indonesia’s monetary easing should allow interest rates to reach 5.5% for the BI Policy Rate in 2017. Recently, a combination of lower inflation and improvement in the Current Account boosted the rupiah. At this stage, lower inflation and widening yield spreads strongly influence the rupiah, allowing sizeable inflows to bond and equity markets. Hence, we expect the rupiah to end the year at Rp 12,800. Furthermore, the government’s tax amnesty funds should reach Rp 300 trillion by 1Q 2017, strengthening the rupiah to 12,500 by end-2017.

    Positive sentiment on the rupiah comes from improving FX reserves, to be further strengthened by tax amnesty repatriation. September FX reserves have increased to $116 billion, up 14% for the year, supported by FX receipts, as well as the government withdrawing loans. Looking at foreign payments, declining imports and debt payments have lifted the foreign reserve to imports to 10.4 months. Last but not least is the importance of political stability  following two years of Jokowi’s leadership, encouraging investment and growth for Indonesia.

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