Key Points

• The Indonesian economy has stayed largely resilient. GDP grew by 5.1%yoy (est. +0.9%qoq sa) in Q1, from 5%yoy in Q4 2023. The pickup was supported by household consumption during the Ramadan and Eid-al-Fitr holidays, as well as election related spending. These drivers helped offset the drag from slowing investment and net export’s negative contribution to growth.
• Looking ahead, we think economic growth will moderate. We forecast real GDP to grow 4.8% this year, down from 5% in 2023. Domestic demand resilience is unlikely to last in the face of tighter for longer monetary policy stance, which will lead to slower credit growth. The boost to Q1 growth from election spending is also a one-off and will fade away. Meanwhile, the decline in goods exports has moderated, but weak Chinese demand and commodity exports will be a drag.
• We forecast the current account to deteriorate to 0.5% of GDP deficit this year, from 0.1% of GDP deficit in 2023. So, the rupiah cannot count on the current account for support. We think the wider current account deficit will mainly be driven by a decline in the non-oil and gas trade surplus, on the back of lower commodity prices. The oil and gas trade deficits could also widen due to higher fuel imports. Indonesia’s goods trade surplus has narrowed to US$7.3bn in Q1 from US$12.1bn a year ago.
• The capital and financial account is likely to have run a deficit year to date due to increased global market uncertainty and its attendant impact on emerging market economies including Indonesia. Indonesia saw large net foreign equity and bond outflows totaling US$2.2bn in April. However, we look for the financial account to return to surplus once global uncertainties over the fed funds rate and geopolitical tensions ease. Moreover, Indonesian assets still have relative attractive yields.
• We forecast USD/IDR at 16,200 in Q2 to reflect capital outflows pressures. But given the strong BI policy response towards a weakening rupiah, the possibility of at least one US rate cut in H2, and the relative attractive yields on Indonesia’s financial assets, we think capital outflows pressure should ease gradually. We forecast the IDR to appreciate modestly to 15,700 per US dollar by end-2024. Key downside risks to our rupiah outlook would stem from higher for longer US rates, a sharp escalation in Middle East tensions, and political transition challenges (Chart 1).

TIGHTER FOR LONGER MONETARY POLICY STANCE TO ANCHOR RUPIAH BUT WEIGH ON GROWTH

 

• Indonesia’s GDP growth picked up to 5.11%yoy in Q1, from 5.04%yoy in Q4 2023, in line with our and market expectations. The main drivers were private consumption (+5.33%yoy from 4.78% in Q4) and government spending (+19.9%yoy from 2.8% in Q4), which helped offset a slowdown in fixed investment (+3.79%yoy from 5.02% in Q4) and the negative contribution (-0.2ppts) of net exports to GDP growth. We estimate that sequential GDP growth slowed to +0.9%qoq in Q1 from +2.4%qoq in Q4 2023.
• Despite resilient Q1 GDP, we have cut our 2024 GDP outlook by 0.3ppts to 4.8%. This follows BI’s 25bp rate hike in April and our revised outlook for the policy rate to now stay higher for longer at 6.25% through this year, as opposed to our previous expectation for 50bps BI rate cuts in H2. Tighter domestic monetary conditions will inevitably weigh on domestic demand. Meanwhile, the regional export outlook has improved, but it has notably been concentrated in AI-driven tech exports. Continued weakness in exports to China (-17.1%yoy in March), still high interest rates in major advanced economies, and lower coal and metal prices mean a sharp export rebound for Indonesia looks unlikely.
• Private consumption growth to moderate. Motor vehicle sales fell 23.6%yoy in Q1, worsening from a 13.5% decline in Q4 2023 and extending the annual decline to the third straight quarter (Chart 2). Consumer loan growth has also shown signs of stagnating, while nominal wage growth has slowed.
• Expect below-trend fixed investment growth. We estimate that fixed investment unexpectedly fell 0.3%qoq sa (+3.8%yoy) in Q1, despite macroprudential measures to support corporate borrowings. We expect fixed investment growth of just 3.4% this year, which would be slower than the 4.4% growth in 2023 and the pre-pandemic pace of around 5.5%. This will be due to the higher borrowing costs, domestic political transition risk, and an uncertain global environment. That said, Bank Indonesia’s macroprudential measures should still provide some support. Corporates have increased their investment loans (+14.8%yoy) and working capital loans (+12.3%yoy) in Q1. Construction investment growth will be underpinned by strategic public infrastructure projects, such as those related to relocating the capital to East Kalimantan (Ibu Kota Nusantara (IKN)).

• The current account is set to stay in deficits this year. We expect the current account to stay in deficit of 0.5% of GDP this year, from 0.1% of GDP deficit in 2023. The manufacturing PMI fell to 52.9 in April from 54.2 in March, on the back of a slower rise in output and new orders, suggesting a sharp export rebound is unlikely in the months ahead. Export volumes of foodstuff, chemicals, coal, and base metals have declined (Chart 3). Falling prices of metals and coal have also weighed on export values. Merchandise goods exports in USD terms fell 7.2%yoy in Q1. Non-oil and gas exports were down by 7.6%yoy in Q1, while oil and gas exports fell 2.5%yoy. Broad-based declines were seen in exports to major trading partners. Notably, exports to China were down by 17.1%yoy in March, while shipments to advanced economies have been falling since February 2023 (Chart 4). Meanwhile, goods imports dropped by 0.1%yoy in Q1. The trade surplus narrowed to US$7.3bn in Q1, from US$12.1bn a year ago. This was not enough to offset services trade deficits and net outflows of profits, interests, and dividends.

WEAK RUPIAH TO KEEP BI HAWKISH FOR LONGER

 

• Our base case is for BI to hold its policy rate at 6.25% this year to help stabilize the rupiah and keep inflation within the 2.5%±1% target range in 2024 and 2025.
• Yes, domestic inflation has stayed within the BI’s inflation target range, despite the recent months of uptick. Headline inflation picked up to 3.05%yoy in March and 3%yoy in April, from 2.8%yoy in February. But this was mainly due to the rise in volatile food inflation (+9.7%yoy in April and +10.3%yoy in March) during the Ramadan and Eid al-Fitr season. This festive holiday effect will fade away. Meanwhile, core inflation steadied at 1.8%yoy in April and administered price inflation was just 1.5%yoy. The main worry for policymakers is thus the passthrough of a weaker rupiah to higher inflation. This explains the pre-emptive 25bps rate hike in response to rupiah weakness. Moreover, the US Fed has signalled for interest rates to stay high for longer.
• We do not rule out further BI rate hikes, given global uncertainty over the future fed funds rate path and Middle East tensions. There remains a risk that USD/IDR could test the peak at 16,600 – a level that was last seen during the Covid period in early 2020, in the event of a sharp escalation of geopolitical tensions. This would likely necessitate further BI rate hikes. A BI policy rate cut is only possible in Q1 2025 at the earliest.

More needs to be done to attract foreign inflows

 

• FDI inflows rising, but more still needs to be done. Foreign investors are focused on national prioritized projects. A lot of FDIs have gone to the metals sector, suggesting the government’s downstreaming policy – ban raw nickel exports to catalyse the development of a nickel refinement sector to increase export values – is working (Chart 5). China is investing to build more smelters to process nickel used in manufacturing batteries. Foreign investments are also rising across various other sectors. However, more needs to be done to incentivise foreign investment. Indonesia’s FDI as a share of GDP, at less than 2% of GDP, is among the lowest compared to several regional peers (Chart 6).

• Capital outflows pressures have intensified in recent months. But we think this could recede, given BI’s strong policy response to rupiah weakness and our anticipation for lower US interest rates in H2 and no escalation to a full-blown war in the Middle East. Global funds have cut their holdings of Indonesian bonds by US$1.1bn in April. This extended the US$1.3bn decline in March, which was the largest monthly net foreign outflows seen since September 2022 (Chart 7). A sharp market repricing of fed funds rates this year, along with market concerns of higher fiscal risks under Prabowo’s government, have hurt sentiment. During his election campaign, Prabowo has pledged to boost spending in health and education, including a plan to distribute free lunches and milk to children. But we think market concerns about fiscal risk is overblown. Indonesia still has a fiscal cap of 3% of GDP deficit. Meanwhile, Indonesia’s equities market also saw US$1.1bn of net foreign outflows in April. The Jakarta stock index is trading below 7,100 at the time of writing, compared to the end-2023 closing of 7,273.

USD/IDR outlook – revising up Q2 forecast on increased global uncertainty

 

• We have raised our USD/IDR forecast to 16,200 in Q2, from 15,850 previously, reflecting increased global macro and financial market uncertainty over future path of fed funds rate and Middle East tensions. Funding liquidity pressures have also increased, though they are still manageable and below the levels seen during stress episodes like the global financial crisis. The 1-month implied volatility on USD/IDR jumped to nearly 7% from 4.7% in early April, before falling below 6% as Iran had signalled it has no plans to retaliate against Israel’s attacks. But simmering tensions keep us cautious about the rupiah.
• BI’s FX instruments will help augment its latest policy rate hikes to stabilize the rupiah. BI has several tools at its disposal to mitigate excessive currency volatility. The central bank has been intervening in the FX market via spot and DNDF, while selling a record high IDR36.26tn worth of rupiah securities (SRBI) in an auction on 3 May, with total incoming bids at IDR37.2tn, mostly 12-month notes (IDR19.68t) at an attractive yield of 7.47%. SRBI auction frequency will also be increased to twice per week to help attract foreign inflows.
• Foreign reserves fell to US$136.2mn in April, from US$140.4mn in March, the largest monthly decline recorded this year. This likely reflects FX intervention by Bank Indonesia and valuations effects. However, FX reserves are still adequate, equivalent to about 6.2 months of imports, which is well above the international adequacy standard of around 3 months of imports.

Several risks to watch for the rupiah

 

• Higher for longer US interest rates: US core PCE deflator rose 0.3%mom (2.8%yoy) in March, similar with the pace seen in February. Notably, core services excluding housing was sticky at 3.5%yoy. Financial markets have pared back expectations of fed funds rate cuts to less than two US rate cuts through January 2025. In a scenario where the US Fed kept fed funds rate unchanged at 5.25%-5.50% this year, we think USD/IDR could settle at around 16,000 by end-2024 versus our baseline of 15,700.
• Significant escalation of Middle East conflict: For now, geopolitical tensions in the Middle East have ebbed after Iran signalled it will not retaliate against Israel’s attacks. But in a scenario where there are miscalculations by either party in the coming months, Middle East tensions could escalate sharply, resulting in heightened global uncertainty with Brent prices rising to US$120/barrel. In such a scenario, we think USD/IDR could spike to 16,600 before settling at 16,450 by end-2024 as the geopolitical shock eases, versus our baseline of 15,700. This would also likely elicit another BI rate hike to stabilize the rupiah.
• Political transition risks: With Prabowo winning the presidential election in one round, election uncertainty has eased. Still, we remain mindful of potential political transition risks stemming from the forming of a governing coalition among the different political parties and the appointment of key cabinet members. Notably, there remains an element of uncertainty for investors regarding the composition of Prabowo’s cabinet, particularly over who will be the next finance minister. Indeed, current finance minister Sri Mulyani has been a seasoned hand in managing government finances and keeping the budget deficits within the fiscal deficit cap of 3% of GDP, barring during the Covid years in 2020 (-6.1%) and 2021 (-4.6%). Prabowo is reportedly considering several former bankers to replace Sri Mulyani. They include Health Minister Budi Gunadi Sadikin, Deputy Minister of State-owned Enterprises Kartika Wirjoatmodjo, financial regulator chairman Mahendra Siregar, and Bank Negara Indonesia president director Royke Tumilaar.