Global Trade War

On Friday (06/07) the global trade war kicked off as the USA imposed import tariffs on USD $34 billion worth of Chinese goods. China vowed to retaliate. But this move would then certainly be met with new US import tariffs, thus escalating the issue further. The trade war gives rise to concerns about global economic growth as well as the impact of the import tariffs on the global supply chain.

Meanwhile, the USA said it is reviewing 124 Indonesian products that are shipped to the USA. These items could also become subject to import tariffs and may provoke retaliatory moves from Indonesia's Trade Ministry; a situation that would be bad for both countries.

If economic growth in the United States and China is undermined by the trade war, then it will have a direct impact on Indonesian exports and - more generally - an impact on the Indonesian economy as China and the USA are both among Indonesia's biggest export destinations. Meanwhile, raw materials and commodities that are supplied by Indonesia to China (to make those products that have now become subject to US import tariffs) are likely to become affected as demand for these raw materials/commodities is expected to fall accordingly.

Current Account Balance

Secondly, Indonesia is among a selected group of Asian emerging markets that are plagued by a wide current account deficit (together with India and the Philippines), particularly due to these countries appetite for crude oil imports. This deficit undermines investors' confidence in Indonesian assets and thus puts pressure on the rupiah as Indonesia has become dependent on external flows to finance its external deficits (which also determine the stability of the Indonesian rupiah).

Indonesia's current account deficit was recorded at USD $5.5 billion, equivalent to 2.15 percent of the nation's GDP, in the first quarter of 2018. This was a steep increase compared to Q1-2017 when the deficit was recorded at USD $2.4 billion (or 1.0 percent of GDP). Thus, Indonesia's current account deficit more than doubled, a development that is particularly due to rapidly rising imports. Meanwhile, the full-year 2018 deficit may fall somewhere between 2.1 - 2.5 percent of GDP.

Indonesian Finance Minister Sri Mulyani Indrawati therefore said that the Indonesian government plans to review the import of capital goods for big government projects in an effort to reduce the country's current-account deficit. It was reported that in the first five months of 2018, Indonesia imported USD $4.1 billion of goods in relation to government-led infrastructure development projects.

Interest Rate Environment

Meanwhile, in an effort to defend the rupiah, Indonesia's central bank (Bank Indonesia) significantly raised its benchmark interest rate over the past two months (the benchmark rose gradually from 4.25 percent in early May to 5.25 percent in late June). Higher borrowing costs may lead to reduced appetite for credit, implying that Indonesia's credit growth remains subdued. Based on the latest Bank Indonesia data, credit growth in Indonesia's banking sector had risen by 8.9 percent (y/y) in April 2018, accelerating from a pace of 8.5 percent (y/y) in the preceding month. Prior to 2016, Indonesia had become used to double-digit credit growth figures.

Interestingly enough, robust credit growth prior to 2016 was recorded despite the higher benchmark interest rate in those days. And while we see a strong co-relation between Bank Indonesia's rate cuts/hikes and credit growth/decline between 2006 and 2016, this co-relation seems to have disappeared after 2016: while Bank Indonesia cut the benchmark interest rate sharply in 2016-2017, this was not followed by a rebound in credit growth. Therefore, it is not unimaginable that the recent rate hikes in Indonesia will not cause a significant decline in credit growth.

Legislative & Presidential Elections 2019

Generally, the 2018 local elections - held on 27 June 2018 - went orderly. However, the quick count results are seemingly indicating that the battle for the presidency next year will become a close battle (we detected a strong rise in support for Gerindra-backed leaders; Gerindra being Prabowo Subianto's political party, who is likely to become the sole rival of incumbent President Joko Widodo in the 2019 election). With reform-minded Widodo being the market-favorite, perceptions of a tight battle give rise to uncertainty about Indonesia's political make-up and economic orientation after 2019.

All in all, for this moment Indonesia Investments maintains our 5.2 percent (y/y) growth projection for the Indonesian economy in full-year 2018, and we believe that the Indonesian economy will continue to show modestly accelerating growth on a y/y basis (as it has done in recent years). However, there is a chance that we need to downgrade this figure to 5.15 percent (y/y) in the near future considering the challenging context.

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