Macro Strategy

Growth vs Stability Narratives

 

  • Maintaining fiscal stability will be imperative despite the larger deficit outlook. Priority budget reallocation will be primary.
  • Expansion of the fiscal deficit would improve the growth outlook, but if not done gradually, it would risk Indonesia’s fiscal stability narrative.
  • The key near term macro risk would be inflation. The rice harvesting season partially alleviates supply risk ahead of the festive season.

Moving forward. Positioned as a "quick win" initiative by the leading presidential candidate, Prabowo Subianto, for the upcoming presidential term, the implementation of a "Free Lunch" program has garnered substantial support from both the current and prospective governments. Initially discussed in a cabinet plenary meeting, the program was subsequently launched as a pilot project at a State Junior High School in Tangerang last week, allocating Rp15k per meal (excluding milk). Despite receiving mixed reviews, the government emphasizes that the pilot project aims to showcase the practicalities and potential multiplier effects of the program. In addition to cautionary notes from rating agencies, the World Bank underscores the importance of prioritizing fiscal stability in Indonesia. According to our projections, by 2027, the government will need to explore significant additional revenue sources to stay within the 3% fiscal deficit limit. One potential option is reallocating funds from other budgetary areas, a strategy employed during the pandemic year, particularly in sectors such as infra, social protection, and healthcare.

 

Growth vs Stability.  Expanding on our analysis from the preceding two reports, we now explore the broader economic implications, particularly focusing on growth and stability, as the government intends to increase the deficit to a range of 2.4-2.8% in 2025 to fund the program. Growth: The substantial spending associated with this program is expected to influence growth, similar to other government expenditures. However, in contrast to infrastructure and education spending, which typically yield long-term effects, this program is foreseen to have an immediate impact on consumption, resembling fuel subsidies due to its daily spending nature. With the rise in purchasing power, there is the potential for an overall GDP boost, positively influencing sentiment in the equity market. Nevertheless, it is essential to consider potential inflationary side effects. Upside risks to inflation could subsequently impact interest rates and yields, leading us to the second implication; Stability: Indonesia's fiscal policy has consistently received praise for being among the most prudent, evidenced by relatively manageable fiscal deficit expansion during the pandemic years. The state budget deficit post-pandemic was successfully reduced to below 3% faster than expected, reaching only 1.7% in 2023. While this underscores a commitment to stability amid escalating external risks, larger consumption-based fiscal spending could potentially rely on increased borrowing, as indicated by the government's plan to widen the deficit next year. This raises concerns about fiscal stability and its impact on bond yields. Our observations indicate a positive correlation between disinflation and lower yields, with the policy rate acting as the bridging mechanism. Reflecting on the period of fiscal deficit from 2013 to 2021, we note consistent positive correlation with the widening yield spread (UST vs INDOGB 10 yrs) persists, although each year may present a unique narrative. In the upcoming year, we anticipate a similar scenario as the presence of inflationary risks suggests that any rate cuts will likely occur at a slower pace, and our baseline projection indicates a prolonged widening yield spread.

 

Lesser Inflation Risk on Harvest season. Although assessing the potential outcomes of the government's plans remains arduous and requires more concrete and detailed announcements, the prevailing macroeconomic risk continues to be inflation. In the short term, there is an expectation of a rice harvest in early March, which could alleviate the current inflationary pressures arising from the rise in rice prices (+5.32% m-m in Feb-24). In Feb- 24, inflation accelerated to 2.75% y-y (+0.37% m-m), representing the highest monthly inflation for February. Approaching the holy month of Ramadan, there is anticipated mounting demand pressure for inflation, potentially intensifying the supply constraints that have been fueling our recent inflationary trend. The government has announced to do more extensive market operation to rein in rice price, both to traditional and modern market channel. Considering all these factors, our base case supports the expectation of no further changes in interest rates in the first half of 2024.

 

Capital Market – Election Exuberance Inflow Halted

 

Fixed Income – While initially US Treasury 10-year bond yield rose from 4.26% to 4.31% on 27th Feb, it retreated to 4.19% on 1st Mar mainly underpinned by downward revision on the second reading of 4Q23 US GDP growth and a reduced PMI manufacturing index. The 10-year yield on Indonesian Government Bonds (INDOGB), however, increased from 6.57% to 6.62% as Bank Indonesia recent buying activity appears to recede. In the currency market, the Dollar Index gained 0.20% which led to IDR 0.67% weekly depreciation to Rp15,700. The 5-year Indonesian Credit Default Swap (CDS) rose by 1 basis point to 69 bps.

 

Fixed Income Flow – Based on Ministry of Finance (MoF) data as of 29th Feb, it indicates weekly foreign inflow of Rp940 bn with overall ownership reaching Rp837.13 tn, reversing persistent outflow trend in recent weeks. However, foreign still registered an outflow of Rp4.76 tn on the MTD basis. The reversal also seen in tn the banking sector, whereby it registered weekly inflow of Rp17.51 tn (MTD outflow of Rp84.61 tn) as well as on Bank Indonesia (excluding repo transactions) activity whereby it turned to weekly outflow of Rp5.42 tn (MTD inflow of Rp131.95 tn). Mutual funds saw a weekly outflow of Rp400 bn, while insurance and pension funds had an inflow of Rp780 bn.

 

Equity Flow – The end of election exuberance inflows, with foreign finally turned to outflow in the 4th week of Feb-24, totaling Rp2.4 trillion; however, the JCI witnessed a positive 0.2% weekly return which suggest stronger domestic buying activity. On Year-to-date (YTD) for 2024, the inflow in the regular market amounted to Rp12.7 tn, while it reached IDR9.0tn on MTD basis (1 Feb – 1 Mar 24), primarily driven by buying actions in Big-4 Banks amounting to Rp6.9 tn, constituting approximately 77% of the total MTD inflow. Following closely were TLKM, AMMN, FILM, MEDC, and BRIS. Conversely, MDKA, ASII, GOTO, and PGAS consistently remained among the outflow list.

 

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