Indonesia: Firm growth allows BI to focus on FX stability
- Seasonal drivers lifted 2Q23 GDP by 5.2% yoy
- Support from the trade sector is waning
- 2H23 momentum is likely to be influenced by pre-election trends
- With inflation back in target, BI can focus on rupiah stability
- The pivot towards rate cuts stands to be delayed, despite a comfortable real rate cushion
Firm growth report for 2Q23
Highlights and drivers
The Indonesian economy expanded 5.17% yoy, close to our forecast at 5.1% and higher than the 4.8-5.0% projected by market participants. Along with expectations, sequential growth quickened to 3.86% qoq nsa, recovering from -0.9% at the start of the year.
Domestic demand improved across the board, with household consumption up 5.2% yoy vs 4.5% quarter before, benefiting from seasonal factors, including Lebaran-related spending, disbursement of the thirteen-month bonus, social aid disbursements and easing headline/core inflation. On an indexed basis, i.e., compared to 4Q19, real GDP is now up nearly 10%, boosted by a 6.7% growth in household consumption.
General government consumption recovered sharply to 10.6% yoy (vs 3.5% in 1Q), presumably on higher provincial activity, besides fixed capital formation at 4.6% (2.1%). The latter likely reflects improvement in investment commitments into the resource industries and still-favourable cost of financing owing to only a measured policy transmission. External trade was a drag as goods & services exports shrank -2.8% in a sharp reversal from +12.2% in 1Q, besides a 3% drop in imports (3.8% in 1Q). This signifies a normalisation in export receipts on the back of a correction in commodity prices, including base metals, coal, and palm oil, just as imports picked up in the quarter on inventory build-up. The latter is expected to have overshadowed the pick-up in tourism-related earnings and lower transportation costs.
Based on contribution (see chart), final consumption added the most to the headline (an increase of 0.9 percentage points in 2Q23 vs 1Q), followed by gross capital formation (+0.8pp) and statistical discrepancy (0.4pp). Contribution of net export stood at nil, vs 2.0pp in 1Q and an average of 1.3-ppt in 2022.
Under the industry-wise breakdown, all sectors registered increases from 2Q22 levels, barring mining & quarrying, which shrank 11.5% yoy due to a high base and modest slowdown in services on aggregate. Amongst provinces, the heavyweight Java Island contributed 57.3% of overall output, rising 5.2% yoy, followed by commodity-rich Sumatera (21.9% share) and Kalimantan (8.3% share).
Favourable base effects and seasonal factors boosted 1H23 growth, averaging 5.1% yoy. In the second half of the year, the normalisation in quarter-on-quarter growth is likely to be accompanied by pre-election catalysts. Our event study around the past four election cycles (Indonesia’s economy and markets around elections) points to a moderation in growth on average in the run-up and recovery a quarter after the polls. Three Presidential contenders are at the forefront, with their vice presidential appointments under watch. With private surveys pointing to an undecided electorate, pre-election spending is likely to be significant, buoying consumption. On the other hand, domestic and foreign investors will prefer to gain clarity on the election results before making fresh commitments. Goods trade is expected to decelerate further on softer commodity prices and slower global demand (China, Europe, etc.), with an eye on the El Nino developments. We retain our full-year growth forecast at 5% for the year.
BI extends pause to preserve rupiah stability
Bank Indonesia will seek to balance favourable domestic developments against global uncertainties to determine the path ahead. Monday’s firm growth outcome aligns with the central bank’s constructive view on the recovery path.
In July, BI left the benchmark seven-day reverse repo rate unchanged at 5.75% for the sixth consecutive month. Inflation has been on the retreat and is back within the target (2-4%). The July print eased to 3.1% yoy vs 3.5% the month before, the weakest since Mar22. Core eased a notch to 2.4% from 2.6%, besides administered inflation down to 8.4% from 9.2% and supply-side gauge volatile food segment falling -0.03%, the weakest reading in the current series. In terms of contribution, 50% of the drop in the headline was on account of food, bevs & tobacco, 20% utilities, and 15% transportation.
Favourable base effects are likely to push headline inflation below 3% by Sept-Oct, compared with the year-ago period when subsidised fuel was raised sharply. Even if inflation inches back up towards 3.0-3.3% yoy by Dec23, this will leave Indonesia’s real rates at ~275bp, amongst the highest in the region and above the 2017-2019 average of 210bp, effectively leaving the room to ease rates.
We had previously pencilled in a pivot towards rate cuts in Aug/Sep, counting on easing inflation and a stable currency. While inflation has evolved along our projected path, the central bank’s focus has shifted to rupiah stability to contain imported inflation and mitigate contagion risks from global uncertainties. The rupiah is still up ~2.5% on a year-to-date basis vs the dollar but has lost ground in 3Q (-1.2%) on slowing exports, moderation in the reserves stock, and a bid dollar. Authorities have maintained that they prefer to address FX volatility through intervention efforts rather than further tightening moves. They are also hopeful that the recent fine-tuning in regulations of FX proceeds (see here) will be an additional tailwind for the currency, with officials expecting $9bn monthly inflows on this count. Governor Warjiyo expects the US Fed to hike rates in July and September. If this comes to pass, the BI benchmark rate will converge with the US FFR at 5.75%.
Despite a comfortable real rates cushion and easing inflation, the authorities’ discomfort with the choppy currency movements suggests a policy pivot might be delayed to early-2024. This assumes that by the turn of the year, the US Fed will have settled into an extended pause, helping to stabilise the USD, and by extension, the rupiah. If these two developments occur in 4Q23, we attribute a 40% chance that rate cuts might be brought forward to late-4Q23, hinging on the US Fed’s pause in September, limited fallout of the El Nino conditions on inflation and a stable rupiah.
Ahead of the pivot, authorities might consider reduction in the reserve requirement ratio (RRR) which was raised aggressively last year just before the rate hike cycle commenced in 3Q22. Macroprudential measures to boost loan growth are already underway. BI tempered its 2023 loan growth forecast to 9-11% in July, compared to 10-12% projected earlier. The RRR will be lowered for selected sectors from Oct 1, helping to release liquidity worth IDR48trn to banks to boost lending to priority sectors including commodity down-streaming, tourism, etc. As the election cycle heats up, fiscal support might be counted upon to support growth, in case of downside risks.
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