DESPITE benign domestic conditions, Indonesia's financial markets are continuing to feel the heat from the emerging markets sell-off, DBS economists observed in a Sep 4 note. Inflation in August was softer than expected at 3.2 per cent year-on-year, comparable to July and within the Bank of Indonesia's target of 2.5 to 4.5 per cent.
The DBS economists noted that the fiscal deficit run-rate is well within the budgeted -2.1 per cent of GDP, while the government debt to GDP ratio is low at 28.7 per cent, as of end-2017. Yet "pain points exist": firstly, the current account deficit, though contained below 3 per cent in 2018, is expected to widen from 2017 and implies higher financing needs; secondly, "sizeable foreign ownership of domestic bonds, coupled with higher corporates’ dollar debt, in a strong US dollar and rate environment, have seen the currency more prone to weakness".
Indonesian authorities have been actively supporting the domestic FX and bond markets, but amidst a broader slide in regional currencies, it will be a challenge to reverse the rupiah's downward trend, they added. With subsidy reform or fuel price liberalisation unlikely before next year’s elections, they expect more policy defence and administrative measures aimed at containing the currency and current account deficit to be upcoming.
ING senior economist Joey Cuyegkeng similarly sees further monetary tightening on the way, saying: "Bank Indonesia remains focused on stabilising the rupiah, which could mean another rate hike at the September 27 meeting." With the rupiah weakening by 1.5 per cent in two weeks amid the emerging market sell-off, the central bank remains vigilant about a weakening currency and its implication for financial sector stability, he noted. Follow-through tightening at the Sep 27 policy meeting "would not only help stabilise IDR but also moderate demand-pull inflation pressures which would keep inflation over the policy horizon well within the inflation target range".
The DBS economists, however, said: "Sentiment needs to improve for IDR rates to stabilise." While they do not see the current sell-off -- driven by worries about Turkey and Argentina spilling over into other emerging markets -- as warranted, given the lack of clear links between Indonesia and those two countries, they expect respite for emerging market rates to be elusive in the near term. "Between EM contagion, Fed hikes and trade war, it might prove difficult for investors to take on local debt risks at this point."