Indonesian Strategy:Melt up

Rupiah supported by large inflows into the bond market: Notable thisyear has been large inflows into Indonesia’s government bond market, withIndonesia’s 10yr yield compressing from 8.7% to 8.0%, and foreign ownershipof Indonesian rupiah government bonds pushing all time highs, at just under40%. We have been concerned that growing EM/external volatility couldtrigger weakening inflows but so far we have been wrong and the reverse hasin fact occurred, with EM bond investors reallocating funds towards Indonesia.

Falling inflation has been a key driver, with headline CPI inflation havingdeclined to just over 4% from 7–8% mid/late last year, which has improvedthe perceived real yields available on Indonesian government bonds in ayield-starved world. However, there is a tangible risk this decline in consumerprice inflation could be merely cyclical, not structural. Like other countries,Indonesia has been deriving a disinflation dividend from falling oil prices, withat-the-pump prices down about 20% vs. November 2014 levels. However, inaddition, the CPI has been benefitting from a loss of corporate pricing powerand shrinking margins (bad for equities), and overlooked has been the factthat IMF/OECD PPI estimates, as well as BPS wholesale indices, suggest PPIinflation has remained in the high single digits. If corporate margins continueto fall and oil prices remain weak, inflation could remain cyclically low until2017 but margins and oil prices cannot fall forever, and to structurally decline,Indonesia’s wage-price-spiral will eventually need to be stemmed.

4Q GDP beat plus strong BBRI/BBTN results triggers JCI ‘melt up’:Supporting the equity market on Friday was Indonesia’s 4Q15A GDP growthcoming in at 5.04% – an acceleration from 4.7% in 9M15A – coupled withsolid 4Q15A results from BBRI/BBTN. The market has concluded that thecycle has turned. However, as we have discussed in past research,Indonesia’s fiscal deficit rose sharply (and unsustainably) HoH in 2H15A,which quite naturally provided some growth support HoH but this may proveto be merely a short-term cyclical boost, rather than a structural turnaround,given that structural headwinds continue to grow. In addition, BBRI/BBTN are‘special case’ banks, enjoying, respectively, a robust micro franchise andniche position in subsidised mortgages, so the market may be reading toomuch into these results (meanwhile, BBNI’s 4Q missed on asset quality).