Bahana Macrosight: Markets moving ahead of Bank Indonesia

Summary:

·         BI hold key rates at 3.75% as expected

·         10-year bond yields dropped to 5.9% despite unchanged BI rate

Markets think interest rate should – and would – go lower

We think it important to differentiate what Bank Indonesia would do and what the markets think, or price-in, ahead of the central bank’s important rate decision. Previously, we were among the small minority of economists forecasting the key BI rate to be cut 25-bps to 3.5% on Thursday – it was decided later to keep the BI rate unchanged at 3.75%. But it did not matter. In the end, investors positioning themselves for a rate-cut were handsomely rewarded, with yields dropping in the fixed-income market and interest-rate sensitive stocks rallying in the equity market. In fact, the rallies did not falter after the rate-hold announcement, which means the market was pretty much believing BI still has ample space to slash rates again in January. Our base case now is for BI to cut the rate to 3.5% in 1Q21, before embarking on a long pause as the central bank, facing a jump in money supply and potential uptick in inflation, mulls an exit strategy to the current easing cycle.

Reaffirming our USD:IDR 13,500 forecast for 2021

We expect the BI rate outlook next year to be tied closely to US interest rates. Therefore, it is encouraging to know the US Federal Reserve, which held their monetary meeting just hours prior to BI, announced the continuation of its ultra-loose monetary policy, pledging to keep its key rate near-zero for some time. The Fed also pledged to maintain its monthly bond-buying program at USD120bn, or still substantially larger than USD40-85bn in the aftermath of the 2007 Global Financial Crisis. As IDR assets are particularly sensitive to movements of US interest rates and the DXY dollar-index, the Fed’s loose monetary policy should translate into a bullish macro-economic backdrop for Indonesia in 2021. On the external balance front, we expect global economic recovery to continue to support commodity prices, thus bolstering Indonesia’s exports. This means that Indonesia’s trade surplus can be sustained next year (our forecast: USD8-12bn of annual trade surplus next year, compared to USD19.7bn in Jan-Nov 2020). We think gains from both commodity and manufacturing exports would suffice to offset a potential rebound in capital goods and raw-material imports next year.

Will there be bond supply concerns in 2021?

We attended the annual financing strategy briefing held by the Finance Ministry’s Debt Management Office (DJPPR) today. The government announced that it targeted IDR1,654tn of gross debt financing for 2021 (5.7% of fiscal deficit), or slightly higher compared to IDR1,635tn this year (6.34% of fiscal deficit). For next year, the funds would be mostly raised through bonds issuance (IDR1,535tn), with the composition of regular domestic IDR bond issuance (IDR1,246tn, 80-85%), overseas FX bond issuance (IDR159.2tn, 12-15%), and domestic retail bond issuance (IDR76.8tn, 4-6%). We think the big question mark here is how the government would raise IDR1,535tn from the bond market next year without support from: 1) BI, which in 2020 contributed IDR397tn of financing through private-placement mechanisms in a one-off burden-sharing scheme (SKB-2), and 2) commercial banks, which are likely to disburse more credit and buy less government bonds as the economic recovery gains traction in 2021. Should the risks associated with bond supply remain unresolved, Indonesia’s 10-year government bond yields could easily claw back to 6.5-7.0%, in our view. However, we think the yield climb is more likely to materialize later than sooner, approximately 4Q21, or only when inflation may begin to creep up as a result from rapid money supply growth.