BI rate hike: Slower growth ahead

Harry Su
Senior Associate Director
Head of Research

In response to the government’s decision to raise fuel prices by 31% or IDR2,000/liter, which should result in about 200bps hike in 2014 inflation (Bahana: 8.1%), the Indonesian Central Bank surprised us as well as the market yesterday with its decision to raise the BI benchmark rate by 25bps to 7.75%.

This is undoubtedly a hawkish move to slow lending growth as lending facility rate was also raised by 50bps to 8.0%. Our economist is currently revisiting his macroeconomic forecasts on the back of these major developments which occurred in the past couple of days.

During our recent global roadshow to the US, Canada, UK, Europe and Japan, many investors we met with expressed concern on the impact of a possible move by the Fed to raise interest rates next year. Foreign investors agreed with us that the local interest rates would need to rise, in line with higher rates in the US next year.

With that said, we continue to pencil in another 25bp hike in BI rate to help defend the IDR and contain foreign funds outflow from the country.

With 3Q14 earnings coming in generally lower-than-expected, higher interest rates would mean continued soft performance for stocks under our coverage. At this stage of the market cycle, we reiterate our cautious view on interest rate sensitive sectors: Consumer Discretionary, Property, Cement and Poultry, which have the propensity to underperform the market 3-months post fuel price increases in the past (exhibit 1).

On automotive and banks, the sectors’ past tendency to rebound post fuel price hikes (exhibit 2) may not recur this time around, in our view. This is due to the automotive sector’s weak fundamentals on continued intense competition, leading to margin pressures ahead. For the banks, we believe its market outperformance in the past 3-months (exhibit 3) would provide the market with the basis for profit taking, particularly given slower-than-expected loan growth and higher provisioning on worsening NPLs ahead.

Additionally, we maintain our negative stance on Coal as the sector is likely to see weak earnings since pricing for 2015 contracts are normally conducted in 4Q14, coinciding with current weak coal prices.

On a more positive note, we retain our view that earnings for our preferred consumer staples (UNVR, GGRM, KLBF, ICBP, KAEF) should remain resilient, providing shelter for investors. On lower oil prices, we expect staple stocks to experience lower COGS and higher gross profit margins (GPM). Note that historically (exhibit 4), GPMs of staples we cover are perfectly correlated with oil prices (i.e. with a three month lag), and could see up to 200bps expansion. Hence, we think earnings upgrades for the staples are on the cards despite the current economic slowdown.

Moreover, we also like PGAS’ and the telco sector’s defensive nature. Finally, JSMR, which benefits from inflation-adjusted toll-road tariffs, rounds up our top 10 picks.