Second quarter GDP growth was stronger than expected at 6.2% YoY (consensus: 6.0%), up from 5.7% in 1Q. On sequential basis, we reckon the economy grew 6.5% (QoQ, saar) from the previous quarter, accelerating from 5.3% in 1Q and rising above the 5-year average growth rate of 5.8%.The upside surprise mainly came from private consumption, an essential growth driver in Indonesia which accounts for near 60% of real GDP. Private consumer expenditure in the GDP accounts rose 5.0% YoY in 2Q, significantly up from 3.9%in 1Q; well in line with the uptick seen in high-frequency indicators such as motorcycle sales, motor vehicle sales and consumer loans. The QoQ growth in private consumption was even more impressive, at 5.7% (saar).
By contrast, there is no excitement on the investment front, despite media news and market talk about FDI inflows. Gross fixed capital formation rose 8.0% YoY in 2Q, only slightly higher than 7.8% in the preceding quarter; and its QoQ growth in fact was more modest at 5.0% (saar). Meanwhile, exports of goods and services slowed as expected (similar as the regional trend), from 20.0% YoY in the Jan-Mar period to14.6% in Apr-Jun (2.5% QoQ saar). Government consumption remained weak after falling sharply in the beginning quarter of this year (-9.0% YoY in 2Q), reflecting the continued withdrawal of fiscal stimulus as we have observed in the monthly fiscal data.
On the supply side, the strongest growth (on YoY basis) was seen in transport &communication (12.9%), followed by hotels & restaurants (9.6%), construction (7.2%), and financial services (6.1%). Most of these sectors are services related and should have benefited from the robust growth in domestic consumer demand. Factoring in the stronger-than-expected GDP results in 2Q, we lifted our whole-year GDP forecasts to 6.0% for 2010 (up from 5.5%) and 5.8% for 2011 (up from 5.5%).This implies steady albeit slower growth of 5.5-6.0% QoQ (saar) in 2H10.
Consumption should remain firm thanks to favorable demographics, upbeat consumer confidence (105.7 in July) and bank lending support, but its growth rate is likely to cool somewhat due to the emerging challenges of inflation and growing risks of rate hikes. Export growth is expected to continue easing amid the backdrop of a slower global economic expansion. Investment has the potential to pick up if the government can continue to push forward structural reforms and maintain macro stability to boost foreign investors’ confidence and attract more FDI inflows, but the process may take time. In addition, we lifted inflation forecasts to 5.1% for 2010 and 6.5% for 2011, up from the previous forecasts of 4.7% and 6.3%. Although the faster-than-expected rise in July inflation was largely due to the jump in food prices, we caution against the risks of inflation pass through, given the facts that the economy’s output gap has stayed positive for three consecutive quarters, consumer demand is strong, and consumers’ inflation expectations have crept up obviously.
Strong economic growth and higher inflation should persuade the central bank to tighten monetary policy. Bank Indonesia has indeed shifted to a more hawkish stance at the MPC meeting this week, stating that it is “taking careful note of the recent rise in inflation” and “will pursue the necessary policy actions to ensure that inflation remains within target”. This corroborates our view that BI will hike rates this year. As BI has indicated that they prefer to tighten liquidity via adjusting banks’ reserve requirement ratios before hiking rates, we revised the timing of the first rate hike to 4Q from 3Q. We now expect the overnight reference rate will rise to 7.0% by end-2010 and 8.0% by mid-2011.
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