Citi Indonesia economics Vulnerable to Risk Aversion

Economy is likely to slow down significantly led by a sharp slowdown in
investment.

We think domestic demand slowdown seen in 4Q08 will intensify in 2009F, despite some temporary uplift from election-related spending. We expect real GDP growth to slow to as low as 3.5% in 2009F, slowest growth since 1999,and post modest recovery of 4.6% growth in 2010F. We expect the government’s track record of under-spending will keep the budget deficit below plan at 2% of GDP, and provide only a limited support.

Current account expected to improve marginally in 2009F. Sharp slowdown in investment should be positive for Indonesia’s current account balance given that raw materials and capital goods accounted for 93% of Indonesia’s total import bill in 2008. With weaker exports, the net improvement in the current account should be modest – from near zero in 2008 to a small surplus of 0.4% of GDP.

Inflation likely to decelerate sharply but IDR volatility complicates BI moves. After BI cut policy rates by 125bps, we expect more monetary easing for a terminal rate of 7% this year though IDR volatility could slow the pace. Despite rate cuts, we
expect loan growth to slow to around 15%-18% this year on slower demand and rising credit concerns. Rate cuts are not translating to lower yields beyond the SBI bills – IDR bonds have sold off on the back of risk aversion (foreign holdings have declined by IDR5.94trn year-to-date to IDR81.7trn).

IDR remains very vulnerable to risk aversion. Easing depreciation pressure will hinge on recovery of offshore funding flows. The key concern is the potential amount of private sector debt rollovers this year – at least $18bn – which will likely face increasingly difficult refinancing prospects. These potential drains need to be offset by sovereign borrowings, but the continued delays in bond issuance and uncertainty on timing of the standby facility as well as tapping expanded bilateral swaps, has weighed on IDR.

Government’s ability to fund its budget looks manageable. We expect a combination of significant surplus funds from last year (IDR51.3 trn) and tapping IDR44.5 trn (around US$4bn) of the standby facility cover the higher budget gap, keeping the IDR54.7trn net bond issuance target unchanged. With almost IDR26.1trn of bonds raised year-to-date (versus IDR100trn gross bond issuance plan) and we expect $3-$4bn offshore bond issuance, this would leave an average of IDR3.5trn of monthly issuance of local instruments for the rest of the year, which looks manageable, though tenors are likely to be relatively short.