ECONOMIC UPDATE - Monetary Review
Resilient Domestic, Volatile Global
Still holding the current rate
Bank Indonesia (BI) maintained its 7-day reverse repo rate (7DRRR) at 4.25% in April 2018 board of governor meeting. Central bank also maintained deposit facility at 3.50% and lending facility at 5.00%. Current level of policy rate is assessed as sufficient to support economic recovery in the middle of high global risk.
1Q18 growth is expected to be stronger than 1Q17
BI believed that 1Q18 growth will be better than 1Q17 growth at 5.01%. Previously, central bank forecasted 1Q18 growth will be around 5.11% YoY. Investment in both buildings and non-buildings will increase in line with massive private and public infrastructure projects. In Bank Indonesia’s business activity survey, there were some improvements captured in non-financial corporation in every sector, including primary sectors like mining. BI’s business activity PMI reached 50.14 or the first time since 2012 that BI’s business activity PMI reached expansion territory in 1st quarter. Furthermore, central bank also expected better purchasing power due to social spending acceleration in 1Q18 and higher spending due to regional election 2018. Higher purchasing power was also seen from higher growth of imports, especially capital goods and raw materials. Export growth was also seen to be better driven by commodities and manufacture products. Our view of 1Q18 growth remained in line with central bank view, especially after seeing the huge surplus of March trade balance (see exhibit 1). We see that 1Q18 may reach 5.1% - 5.2% on the back of high investment growth and positive growth of export. Consumption will still struggle as showed by weak retail sales growth at 1.5% YoY (See exhibit 2).
Pressure for Rupiah from CAD eased but global volatility remained high
At first, trade deficit in the first two months of 2018 gave a negative impression of higher than expected CAD in 1Q18. However, huge trade surplus in March eased the expectation of unmanageable CAD. Central bank remained comfortable with current CAD level which is predicted at 2.0% -2.5% of GDP in 2018 while previously it predicted 1Q18 CAD will reached 2.0% of GDP. While fear about CAD eased, global volatility was remain high. At first, we saw that global volatility may ease after Fed gave the projection of future FFR policy in late March. However, global tension was heating afterwards due to trade war between US – China and geopolitical conflicts in Syria. Although foreign inflow has returned to bonds market in first two weeks of April 2018 (USD 2.4 bn inflow YTD), Rupiah still moved steady within Rp13,700 – Rp 13,800 range as central bank kept intervening the market as showed by declining foreign reserve to USD 126.0 bn from USD 130 bn in YE 2017. We still see that global risk will remain high in 2Q18. Market will question once more for The Fed’s stance to increase FFR either 3 times or 4 times in 2018 from June FOMC projection. Current Bloomberg consensus showed significant increase of 4 times FFR hike estimates (see exhibit 3). Since February, we have changed our view to 4 times FFR hike in this year and 2 times increase by 2019. Rebalancing of global bonds index in May-June, previous rating upgrade from Moodys and lower inflation in 2Q18 will give only limited upside to Rupiah and Indonesia’s bonds. We expect annual inflation will be around 2.9% - 3.2% in April due to harvest season and continue to move below 3.5% in 2Q18. Furthermore, central bank also kept its commitment for dual intervention to maintain Rupiah and bonds market stability.
See policy rate on hold in 2018 to support growth recovery
The new deputy governor of bank Indonesia, Dody Budi Waluyo, stated an interesting statement where BI does not want higher rate that will overkill growth. We think it is a strong statement that central bank will not change its stance of holding current rate (because room for lowering rate is almost closed due to global volatility) until it sees a clear picture of domestic recovery. While getting 5.3% - 5.4% or even higher economic growth is still difficult to reach in 1H18, we see that level of growth may be reached in 2H18. Better growth in 2H18 may ensure central bank to start policy normalization in 1H19, following global tightening trend.