Despite pressures on the rupiah exchange rate amid a bullish US dollar ahead of monetary tightening in the USA, the Deutsche Bank, one of the world's leading financial service providers, holds a positive view on Indonesian bonds due to Indonesia’s recent fuel subsidy reforms and solid macroeconomic fundamentals. According to the German lender, Indonesian bond yields seem to have decoupled from the currency’s recent depreciating trend although “continued foreign exchange stress could eventually lead to capitulation from bond investors.
Recently, Indonesian authorities scrapped public subsidies for low-octane gasoline and introduced a fixed IDR 1,000 per liter subsidy for diesel thus reducing the government’s subsidy costs by about 83 percent in the 2015 State Budget. Late last week, the administration of Indonesian President Joko Widodo submitted the Revised 2015 State Budget to the country’s House of Representatives (DPR). This revised budget includes fiscal room of up to IDR 155 trillion (USD $12.4 billion) to be allocated to development of the nation’s infrastructure, welfare and the maritime sector. Meanwhile, the budget deficit has been cut to 1.9 percent of the country’s gross domestic product (GDP) in the revised draft of the 2015 state budget (from 2.21 percent of GDP in the original version).
Indonesian Finance Minister Bambang Brodjonegoro said that fuel subsidy cuts actually save up to IDR 230 trillion in the 2015 budget but as the government still owes IDR 25 trillion to state-owned energy company Pertamina (which distributed subsidized fuels), has to pay electricity subsidies to state-owned utilities company Perusahaan Listrik Negara (PLN) and, lastly, needs IDR 37 trillion for fertilizer subsidies and capital injections in several state-owned firms, not all saved funds fall under the newly created ‘fiscal room’.
Deutsche Bank said in its latest report on Indonesia that both the reforming of the country’s fuel subsidies and continuously falling global oil prices have a positive effect on Indonesia’s trade balance, current account balance, and inflation thus improving investors’ confidence in the financial fundamentals of Southeast Asia’s largest economy. This will also make its bond market more attractive.
Indonesia recorded a trade deficit of USD $2.07 billion in the January-November 2014 period, primarily caused by a wide trade deficit in the country’s oil & gas sector. Meanwhile, its current account deficit was USD $6.84 billion, or 3.07 percent of GDP, in the third quarter of 2014. Indonesia has had to cope with a structural current account deficit since 2011, signalling that the country relies on foreign funding and therefore making it highly vulnerable to capital outflows in times of (global) economic shocks. Indonesia’s inflation pace has accelerated to 8.36 percent (y/y) in December 2014 due to the impact of fuel subsidy cuts in November 2014. However, Deutsche Bank expects the country’s inflation rate to ease to below 7 percent (y/y) in the coming months, and expects a sharper drop in the second half of 2015. This then may provide room for Indonesia’s central bank (Bank Indonesia) to lower interest rates later this year. Currently, Bank Indonesia’s key interest rate (BI rate) is set at 7.75 percent. However, due to looming pressures ahead of higher US interest rates, the institution may want to continue a higher interest rate environment in Indonesia in an effort to avert severe capital outflows.
The Indonesian government conducted two bonds issuances so far in 2015. It raised about IDR 22.8 trillion (USD $1.8 billion) from a rupiah-denominated bond sale (double the IDR 12 trillion target) and USD $4 billion through a sovereign US dollar-denominated bond sale (with investors submitting bids for 4.8 times the amount offered), indicating high demand from investors.
Based on the Jakarta Interbank Spot Dollar Rate (JISDOR), the Indonesian rupiah exchange rate has depreciated 1.03 percent in 2015 (up to 12 January) against the US dollar:| Source: Bank Indonesia