With estimates for Indonesia’s economic growth in 2016 being revised downward to 5.2% from 5.3% and Bank Indonesia not willing to cut rates just because inflation is low, a Deutsche Bank analyst recommends that investors stay Neutral risk in Indonesia and use the current strength in the market to selectively take profit. Viacheslav Shilin published his August 5 research piece titled “Indonesia macro trip notes: setting expectations high…again. Stay Neutral” after meeting with government officials and key quasi-sovereign entities to gauge whether the 12 economic packages introduced by the Indonesian president over the past year have impacted the economy.

Indonesia’s economic growth for 2016 now pegged at 5.2%

Shilin points out that on July 28, MoF revised the 2016 budget to adjust for the lower revenues. He notes that the new ICP assumption in the budget is US$40/bbl, down from US$50. The analyst highlights that revised budget revenues are now at IDR178 trillion, driven by a drop in non-tax revenues from IDR273 trillion to IDR245 trillion. Though as of the end of June, tax revenues were filled by only 34%, the analyst points out that MoF anticipates that this will improve with tax amnesty in place.

The DB analyst anticipates that more MoF borrowings will bridge the budgetary gap and expects ~US$2 billion by year-end. However, he doesn’t anticipate that the newly-proposed budget revision will necessarily translate into a higher amount of external borrowings as the MoF is looking into issuing domestic bonds to sterilize some of the tax amnesty repatriation proceeds. The analyst underscores that if tax amnesty disappoints, the budget deficit could creep up above 2.5%, but if it succeeds, it could result in an unnecessarily stronger IDR.

The analyst believes that if the budget deficit crosses 2.5%, the central government will start cutting administrative costs, while infrastructure spending would be preserved. The DB analyst estimates Indonesia’s economic growth in 2016 at 5.2% (10 bp lower), cut his inflation estimate to 4% from 4.7%, and set his exchange rate estimate at IDR13500/USD (down from 13900). He highlights that oil prices rising by 1USD would add 0.1% to GDP growth.

Bank Indonesia reluctant to trim rates

The DB analyst notes that Bank Indonesia remains committed to its long-term objective of maintaining IDR stability and is not willing to cut rates just because inflation is low and growth needs to be stimulated. He notes that unlike in 2015, IDR risks are skewed to the upside now due to expected tax amnesty inflows. He believes the upcoming reset of a reference policy rate from 12M to 7-day repo should enhance the policy transmission as financial intermediaries will be more likely to start using it as a base for loan and deposit products pricing. The analyst highlights that his firm is still calling for two rate cuts of 25bp each by the end of December.

The DB analyst points out that demand for external funding on the part of SOEs is not as strong as one used to witness in the past. He notes that M&A is almost non-existent these days, and Pertamina is perhaps the only SOE among existing bond issuers that has budgeted for some small-to-mid-sized acquisitions in the upstream segment. The analyst doesn’t expect any of the SOEs with existing bonds in the market to issue Eurobonds during the remainder of 2016.

Considering that YTD Indo has been a consensus Long for many Asian/Global EM investors, Shilin believes the yield/spreads in many cases have broken the historic lows/tights and look increasingly vulnerable. The analyst recommends using INDO 5Y CDS as a hedge. Though sovereign bonds and those of PLN look most expensive, the analyst believes Pertamina’s curve still presents some buying opportunities, considering that lower Brent is actually beneficial for this credit. The following table captures the analyst’s top picks and pans in the Indonesia sovereign and quasi-sovereign bonds complex:

Indonesia, Deutsche Bank, Selective Profit Booking