Indonesia Is No Longer So Fragile

new indonesia

Indonesia was a member of the “Fragile Five” (which also included Brazil, India, South Africa, and Turkey) back when markets were in turmoil during the 2013 “Taper Tantrum.”  That is no longer the case due to improved fundamentals, and Indonesia is well-placed to ride out the impact of Fed tightening this year.


One of the biggest changes in Indonesia since 2013 is political.  President Joko Widodo (Jokowi) took office in 2014 and is nearly halfway through his term.  Our base case is that he will be re-elected to a second five-year term in 2019.  Parliamentary elections will be held simultaneously for the first time.

After quickly cutting fuel subsidies after taking office in 2014, Jokowi turned the focus to structural reforms that are meant to boost competitiveness and bring in foreign investment.  The nation now ranks 91 (out of 190) in the World Bank’s Ease of Doing Business rankings, up sharply from 106 in 2016.  He has also put greater emphasis on infrastructure spending.


The economy is picking up modestly.  GDP growth is forecast by the IMF to accelerate to 5.3% in 2017 and 6.0% in 2018 from 5.0% in 2016.  GDP rose 4.9% y/y in Q4, decelerating for the second straight quarter.  As such, we see slight downside risks to the growth forecasts.  Consumer confidence has been climbing since 2015 and is just below all-time highs. This is important, as domestic consumption is a bigger driver of growth than exports.

Price pressures are rising, with CPI accelerating to 3.8% y/y in December.  This is the highest rate since March 2016, but well within the 3-5% target range for five straight months.  This supports the case for steady rates near-term.  Looking ahead, a low base of comparison from 2016 suggests headline inflation will continue to rise this year.

Next policy meeting is March 16, and no change is expected.  The central bank last cut rates 25 bp back in October 2016 but has been on hold since.  If price pressures continue to climb, we believe a tightening cycle may start in H2.  Bank Indonesia is well-respected by the markets, and we do not think it will fall behind the curve.

Fiscal policy has remained prudent but bears watching.  A tax amnesty plan boosted revenues in 2016, but more needs to be done to widen the tax base.  Spending is likely to remain robust due to Jokowi’s infrastructure plans.  The budget deficit came in at an estimated -3% of GDP in 2016, little changed from 2015.  It is expected to remain around -2.5% in both 2017 and 2018.

The external accounts are worsening modestly.  The current account gap was about -1.7% of GDP in 2016, and is forecast by the IMF to widen modestly to -2.3% in 2017 and -2.7% in 2018.  Back in 2013, the gap was -3.2%.  A large portion will be covered by FDI, and so Indonesia’s dependence on hot money flows is not too worrisome.

Foreign reserves have risen to $120 bln in February, the highest since 2011 and near all-time highs.  Reserves cover nearly 7 months of import and are 3 times larger than its stock of short-term external debt.


The rupiah has started to lag after a solid 2016.  In 2016, IDR rose 2% vs. USD and was behind only BRL (+22%), RUB (+20%), ZAR (+13%), COP (+6%), and CLP (+5.5%).  So far in 2017, IDR is up nearly 1% YTD and is in the middle of the EM pack.  Our EM FX model shows the rupiah to have VERY STRONG fundamentals, so this year’s “so so” performance is likely to ebb.

IDR has recouped most of its post-election losses.  However, the exchange rate has been stuck in a narrow 13200-13400 range for most of this year.  For USD/IDR, the December high near 13600 is a major target on the upside, followed by the November high near 13875.  IDR’s direction will largely be dictated by wider EM FX, but the rupiah should outperform.

Indonesian equities have also lagged after a strong 2016.  In 2016, MSCI Indonesia was up 12% vs. 7% for MSCI EM.  So far this year, MSCI Indonesia is up nearly 2% YTD and compares to 9% YTD for MSCI EM.  This underperformance should continue, as our EM Equity model has Indonesia at an UNDERWEIGHT position.

Indonesian bonds have outperformed recently.  The yield on 10-year local currency government bonds is -50 bp YTD.  This is behind only the best performers Argentina (-276 bp) and Brazil (-106 bp).  With inflation likely to continue rising and the central bank likely to move to a more hawkish stance this year, we think Indonesian bonds will start underperforming.

Our own sovereign ratings model shows Indonesia’s implied rating at BBB/Baa2/BBB.  This makes it even more surprising that S&P has not upgraded Indonesia to investment grade BBB- to match the other two agencies.  Indeed, both those ratings have upgrade potential. Note that Fitch recently moved the outlook on its BBB- rating from stable to positive.