Biggest challenges: Inflation & external trade deficit

Arga Samudro
Research Department, Bahana Sekuritas

Relatively in line with our estimate but slightly higher than market expectations, August Consumer Price Index (CPI) declined to 0.47% m-m (July: 0.93%), mainly supported by lower prices of staple foods, clothings, health services as well as transportation costs (exhibit 3) post the Lebaran festivities.
The m-m level translated to a y-y level of 3.99% (29-month low), down from July’s level of 4.53%. Additionally, we also note that the August CPI reached 3.42% ytd (exhibit 2).  In terms of core inflation, August figure, in line with our expectation, slowed to 4.47% y-y (July: 4.64%), on the back of lower inter-city transport tariffs and mobile phone prices.
Despite relatively benign CPI currently, we expect inflationary pressure to escalate ahead due to adjustment on administered prices as follows: (1) Since the new government would have limited fiscal space to accommodate its own programs, we expect the new administration to raise subsidized fuel prices in 4Q14 to ease fiscal pressure and provide greater flexibility. Assuming both regular gasoline and diesel prices are raised by IDR2,000/ltr, our sensitivity analysis shows that 2014 CPI will increase to around 9.9% y-y, up 4%-pt from our base of 5.9%.
(2) The outgoing government has proposed a lower electricity subsidy to IDR72.4tn (-30.3%) in the 2015 state budget, suggesting that there will be higher electricity tariffs ahead. No further details have been disclosed thus far. The 2015 state budget is still being discussed in the parliament.
(3) The government has approved Pertamina’s (state-owned oil company) plan to raise the 12kg Liquid Petroleum Gas (LPG) price. However, details on the tariff hike and timing have not been decided. If Pertamina were to raise the 12 kg LPG price by 14.4%, we expect CPI to increase 0.14%.
On the external trade reading, much lower than our and the street’s estimates, July’s imports contracted 10.5% m-m (-19.3% y-y) to USD14.1bn (exhibit 2) mainly due to slower business activities during the Lebaran holiday. Additionally, 7M14 imports reached USD104bn, down 7.0% y-y.  
Also beyond our and consensus expectations, July’s exports decreased to USD14.2bn, -8% m-m (-6% y-y), due to lower offshore demand for domestic electrical machinery, rubber and jewelries. Moreover, July’s overall exports brought the 7M14 figure to USD103bn, down 3.0% y-y on relatively mixed economic recoveries across the globe.
Despite a slight surplus of USD124mn in July, which was better than our and market predictions, the 7M14 external trade balance still booked a deficit of USD1bn, slightly lower than the 1H14 level of USD1.1bn (exhibit 5).  
Going forward, we believe rising inflationary pressure and relatively stubborn external trade deficit will be the new administration’s main challenges to maintain the macroeconomic stability of Indonesia.