Indonesia’s July trade balance printed a rare deficit, coming in at negative US$0.13 billion. A large bulk of the narrowing in the trade balance owed to imports, which rose a solid 2.5%m/m, sa even as exports moderated to contract 0.9%m/m, sa.
Current account deficit looks likely in next couple quarters - In the case of Indonesia, the trade balance tends to be a large driver of the current account and the recent narrowing in the trade balance reflects slowing exports and strong imports (first chart). This suggests that the current account is on track to print a deficit in 4Q10/1Q11 with the forecast for the deficit to persist into 2011 (second chart, see also “Indonesia’s BoP to lean more on capital account,” GDW, June 11 2010).
A good part of this narrowing in the trade balance reflects the natural ebb and flow of domestic demand, reflected via car sales, which tends to lead to oscillations in the external balances as was the case in 2005 and 2008 and forecast also in 2010 (third chart).
Watching high-powered money and credit growth - Looking ahead, the recent strength of inflows has also led to some leakage into high-powered money (fourth chart). In the case of Indonesia, the expansion in base money growth has historically been a catalyst for credit growth and this cycle is expected to be no different (fifth chart). Thus, credit growth is expected to be buoyant into 2H10 and should reinforce the domestic demand cycle and, in turn, further narrow the current account (sixth chart).
Capital account flows expected to offset current account narrowing – Since the Asian crisis in 1998, the quality of capital account inflows in Indonesia has been poor and thus any narrowing in the current account has not usually been offset by steady capital account inflows. This thus implies that any current account narrowing tends to leave the BoP vulnerable to pullbacks in risk appetite which has been the case in the last decade or so.
However, one encouraging dynamic in 2009 and into 2010 has been the persistence and strength of inflows in the capital account, not only reflecting portfolio inflows in the local bond market but also renewed strength in FDI inflows (table below). Indeed, in 1H10, FDI inflows rose to US$2.9 billion and are expected to print at record levels in 2010. Part of this forecast reflects the expectation that manufacturing wages in Indonesia are becoming increasingly cost competitive which also reflects the recent increase in manufacturing sector wages in China. Indeed, the labor intensive manufacturing sector has seen renewed strength reflected in the recent rise in the textiles industry which could migrate also to low-end electronics manufacturing (see “ASEAN: relative export prices still matter for some,” GDW, April 9 2010).
Thus, the next few quarters will provide an important test for Indonesia and its ability to manage a smooth transition to a current account deficit from surplus.
In J.P. Morgan’s forecast, Indonesia should be able to make this transition relatively smoothly – assisted by unusually low global policy rates and the relocation of low-end manufacturing back to Indonesia.
The best indicator for this transition will be the BoP data. However, in the case of Indonesia, this tends to be very lagged, with the best proxy indicator for the BoP being the trend in FX reserves.
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