Stronger IDR ahead on low oil price

Arga Samudro
Research Department, Bahana Sekuritas

For now, Indonesia is not benefiting from the current low oil price environment due to the government’s recent move to raise domestic fuel prices.  Instead, November inflation was up 1.50% m-m (6.23% y-y) from this price shock, considerably higher than our estimate of 1.15% and slightly higher than the market estimate of 1.41% (exhibit 2). The higher m-m figure brought ytd inflation to 5.75%, which was also pushed up by higher staple food prices and transportation costs.

On core inflation, November figure also rose 0.40% m-m, higher compared to the October level of 0.27%, due to indirect impact of rising fuel prices, including urban transportation tariffs and airline tickets. The m-m figure translates into an annual level of 4.21% y-y (Oct: 4.02%).

Nevertheless, Indonesia should benefit from medium-term structural changes in oil price, in our view, which are caused by several supply-demand factors. (1) China’s economic outlook appears bleak, with most international institutions, including the World Bank and the IMF, expecting lower GDP growth. Weak European economies have also dragged down global demand. (2) In terms of global supply, significant shale-gas production in the US has raised the country’s oil-production capacity to around 9mn bbl/day compared to 5.5mn-6mn bbl/day three years ago (exhibit 5). This increased production should apply greater pressure on oil prices. In fact, apart from declining China demand, we are of the view that the behavior of US oil producers will be a major factor in determining long-term oil prices. (3) We believe the recent OPEC decision to refrain from cutting oil supply quota may be a strategy to challenge rising US oil production. In sum, while we believe the recent decline in oil price will not be sustained over the longer term, we now expect Brent oil price to dip to USD60/bbl (previous estimate: USD95) as of end-2014, before gradually rising to USD78/bbl (previous: USD93) as of end-2015 (exhibit 1).

Looking ahead, the 2015 CPI may be better than expected if Jokowi caps the fuel subsidy amount at a certain IDR/liter, allowing subsidized fuel prices to move in line with the IDR and the Brent oil price (floating scheme). With the downtrend in global oil prices, the public would benefit by directly taking advantage of declining fuel prices. This type of a scenario is not likely to occur under the current fixed fuel-price scheme. We plan to revisit our 2015 CPI target of 5.6% (2014: 7.5%) if the government were to decide to implement a floating fuel-price scheme.

On the trade front, October imports slightly contracted 1.40% m-m (Sept: 5.09%) to USD15.3bn (exhibit 2), mainly stemming from a decline in non-oil and gas imports such as machinery, steel and plastics. This occurred as domestic manufacturers’ demand for raw materials declined.  October imports led the 10M14 figure to contract by 4.06% y-y to USD149.7bn.

Exports slightly rose 0.49% m-m on higher CPO exports: In line with our expectation, October exports reached USD15.4bn, slightly up 0.49% m-m (-2.21% y-y), supported by a rise in palm oil exports and helped by reduced export taxes amid lower global CPO prices. Nevertheless, October exports still slowed 2.21% y-y, bringing the 10M14 figure to USD148.1bn, down 1.06% y-y.

10M14 trade deficit of USD23m helped by improving exports: In sum, the better-than-expected October trade balance of a USD23m surplus, was largely in line with our expectation, helped by improvement in exports coupled with lower imports.  This brought the 10M14 trade deficit to USD1.6bn, slightly lower than the 9M14 level of USD1.7bn (exhibit 8).

Given these developments, we forecast the 2015 average Brent oil price to drop to USD71.4/bbl, paving the way for the current account (CA) deficit to improve, as we estimate oil imports would decline by USD7.4bn. However, a lower oil price would also pull down other commodity prices, including CPO and coal. In sum, we believe the overall impact should be positive on Indonesia with the country’s 2015 CA deficit expected to improve to 1.95% of GDP (previous estimate: 2.7%), before further narrowing to 1.50% of GDP in 2016 (previous: 2.4%).

Fundamentally, an improvement in the CA deficit would likely strengthen the IDR against the USD. Hence, we lower our 2015 year-end currency target to IDR11,500/USD from 11,700/USD and expect the IDR to continue to appreciate to 11,200/USD in 2016 (previous estimate: 11,500/USD).  Note that this is even after our assumption that the central bank would continue to build its FX reserves to higher levels in order to prepare for capital outflows given the Fed’s possible decision to raise interest rates in 2015. As we expect Indonesia’s external trade balance to remain solid, we think our stronger IDR target is conservative at this stage.