Capital flows into emerging markets improved last month on the back of The Fed’s dovish stance. 10-year US T-bills yield edged down to 2.04% while the curve flattened together with continued lower government bond yields worldwide supported by weak US data, possible EU stimulus in December and China’s rate cut.
Coupled with economic slowdown and global deflation concerns, the average inflation in Asian and major economies keep decreasing as growth has continued to stall. As a consequence, some Asian nations have already cut their interest rates.
For Indonesia, we expect current low inflation to continue and we expect some mild -0.03% deflation in October or 6.3% y-y inflation supported by lower prices of electricity, rice and exchange-rate pass through effect. This has us cutting our year-end inflation target to 4.2% from 4.8% previously.
At this stage, the IMF has already cut emerging economies' GDP growth target to 3.1% in 2015 and 3.6% in 2016 while expecting major economies’ GDP growth to quicken. For Indonesia, the global slowdown has already been reflected in lower exports in 3Q15 (-16.3% y-y). On the import front, 3Q15 (-23.5% y-y) figures would suggest that an economic recovery could still be some months away.
On a more positive note, our Current Account Deficit should improve significantly to 1.7% of GDP in 3Q15 as trade balance recorded a strong figure at $2.7 billion USD (2Q15: $2.0 billion USD). The condition is quite constructive in our view and we should see some support from domestic and global investors in the bond market soon.
We expedite our rate cut forecast to 25 bps cut in December to 7.25% and expect 8.2% government bonds yield at the end of the year. More aggressive easing could come next year and we therefore lower our BI Rate expectation to 6.75% in 2016. The downside risk to our view would be lingering concerns on Indonesia’s foreign reserves as a possible increase in net short-term liabilities could limit room for the central bank to intervene going forward.
Amid global economic slowdown, the success factor will be bold coordination between fiscal and monetary policies to boost our domestic economy. We welcome recent government action to tackle the situation especially by lowering energy prices, cutting exporters’ tax for time deposits and asset revaluations.
Finally, on the currency side, the real interest rate gap should not be a major concern as before given that inflation is expected to fall. PPP wise and confirmed by historical data, pressures on IDR/1USD are usually muted during low inflation periods. Nevertheless, we are mindful that further low economic growth supported by tight financial market conditions could be more harmful. Thus, for now, we expect 3Q15 GDP growth data to be at 4.72% (2Q15: 4.67%) backed by seasonally high government spending at 5.47% y-y or 8.0% q-q.
