Economics & Strategy

DBS Focus
Indonesia Outlook 2021: Beyond the pandemic
Economics/Growth/Trade/India

Group Research November 30, 2020

30
Radhika Rao Economics
Economist
radhikarao@dbs.com • 2020 was dominated by the pandemic and its after affects
• Into 2021, besides COVID-19, focus will also be on expanding
manufacturing and investment footprint via the Omnibus push and
RCEP agreement
• GDP growth is expected to get a lift from global tailwinds
• Authorities have taken pre-emptive strides towards vaccine tie-ups
• Macro stability is expected to sustain, with current account balance
Philip Wee in a manageable position
FX Strategist
philipwee@dbs.com • Fiscal deficits and debt levels are likely to narrow in 2021
• Monetary policy faces the currency vs yield advantage dilemma.
Benign inflation leaves door open
Currency
• A stable 14000-15000 range for USDIDR on a conducive landscape
Rates

Eugene Leow • Current conditions are supportive of further gains in IndoGBs

Rates Strategist
eugeneleow@dbs.com

2020 – year that was

2020 was dominated by the pandemic fallout as authorities sought to

balance lives vs livelihoods. Indonesia’s total caseload is amongst the
highest in the ASEAN-6 bloc, with the latest count past 500k. Earlier in the
year, the government opted to impose large-scale social restrictions by
closing public places, restricting public transport usage alongside limiting
Please direct
distribution queries to intra-provincial travel, instead of a complete lockdown or shutdown
Violet Lee +65 68785281
considering the latter’s material economic repercussions. Local
violetleeyh@dbs.com
governments also rolled out measures specific to their respective
jurisdictions. These helped to slow the pace, but not arrest, the infection
spread. Weighed by restrictions, 2Q20 GDP growth shrank -5.3% y/y before
recovering to -3.5% in 3Q, steep contraction by historical standards but
smaller than other regional peers (see chart).

Refer to important disclosures at the end of this report.

Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Fiscal and monetary policy adopted a coordinated approach as we discuss

in the sections below. Taking stock of the asset class performances (see
chart), the rupiah endured a volatile year, partly due to risk-off
sentiments, and other due to concerns over the official stance on deficit
financing and BI independence. Bond yields spiked in first half of the year,
but strong domestic demand, active participation by the central bank and
trickle back in portfolio investments towards late-2020 have seen 10Y
yields correct by over 200bps 3Q onwards. Overall financial and monetary
conditions remain growth supportive, with flush liquidity, interbank rates
well below the BI rate and debt restructuring mechanism lending stability
to borrowers as well as the banking system.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Balancing lives vs livelihoods to persist into 2021

Into 2021, the authorities will continue to balance the health crisis vs
recovery needs until mass vaccination is attained. After a moderation in
the daily caseload, the count quickened into Nov20, as shown in the chart
below. High positivity rate vs peers and weaker testing rate (on per million
basis) suggest efforts to contain the pandemic will continue into 2021.

As demonstrated during the depths of the first wave, complete

shutdown is unlikely, with the response function likely to stay fluid. As
of Nov20, most provinces are in the transitional PSBB i.e. the stage where
large scale social restrictions have been eased to a great extent but is not
completely back to normal (capacity restrictions etc. remain in place). The
most impacted capital city Jakarta had temporarily returned to full PSBB
in mid-Sep but returned to the transitional phase in around a month. Any
re-steepening in the pandemic curve is, thereby, likely to be met by
localised restrictions. For instance, the government plans to shorten the
duration of the year-end holiday to avoid mass gatherings and other
contact intensive interactions to restrain the spread. The centre has also
ramped up efforts to ensure local governments strictly impose and
implement health protocols to counter the pandemic, amidst fears of
another outbreak after crowds gathered at a religious event, according to
the local press.

Testing rates also requires to be stepped up in the coming weeks, which

at present is running at less than half the rate of the Philippines, the other
economy in ASEAN-6 with a high COVID-19 caseload. Better testing

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

numbers would not only help with the subsequent ‘trace and treat’ but
also ease the positivity rate from the current 14%. Bulk of the cases are
concentrated on the Java island, which is also the largest contributor to
growth.

There are also notable strides towards access to vaccines as the

Indonesian government has arranged for licenses with a Chinese pharma
firm and is under discussion of tie ups either for clinical trials, vaccine
manufacturing or procurement with other drug makers. With cold chain
distribution network of the vaccine variants produced by Pfizer-BioNTech
as well as Moderna being onerous, expectations are that sourcing
supplies from the China based partners might be more conducive and
available on priority basis to Indonesia. The Food and Drug Monitoring
Agency (BPMO) signaled that emergency use of vaccine will be granted
once quality, safety and efficacy is assured, once third phase testing is
complete. Nonetheless, even when dosages start, priority is likely to be
provided to frontline workers, patients etc. with mass vaccination few
months away, at the least. Hence, precautionary and preventive tests are
likely to the first line of defense into 2021.

Gradual updrift in growth likely

Imposing strict movement restrictions instead of full-scale shutdown saw

the economy register a comparatively shallow -5.3% y/y contraction in
2Q20 GDP, before recovering on sequential terms to -3.5% y/y in 3Q.
Subdued consumption and investments were partly offset by higher fiscal
expenditure and positive contribution by net exports. Households
consumption continued to slow (-2.4% y/y vs -5.7%) in midst of pandemic-
led economic uncertainty, uptick in the unemployment rate and a gradual
reopening of the economy.

Public spending gathered steam in 3Q (9.8% y/y vs -7% in 2Q) after slower
disbursements in 1H20, concentrated in personnel spending, social
assistance, regional transfers/village funds alongside subsidy payouts.
Capital fiscal expenditure is being scaled back, likely due to reallocations
to make way for the support packages to defend against the health crisis.
Capital formation eased on account of lower fixed asset investments,
machine & equipment and a drawdown in inventories. This was offset by
net exports which contributed positively to headline growth (see chart).
Imports declined faster than the pick-up in exports.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Our inhouse DBS GDP Nowcast model for Indonesia, which analyses an
array of high frequency (monthly) indicators to make a call on the ongoing
and coming quarters on a real time basis, points to a smaller contraction
in 4Q20, before ascending to black into 2021.

For 2021, we count on consumption, corporate restocking and net

exports to benefit from unwinding of restrictions alongside favourable
base effects, while slower fiscal support and direction of the pandemic
curve are risks to the outlook. The recast window for corporates and
deferred NPL classification to provide some succour to the banking
system in the near-term. We maintain our GDP growth forecast at -2%
y/y for this year and 4% in 2021.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Fiscal support will be crucial in 2021

The government undertook timely fiscal support measures referred to as

the national economic recovery, comprising of higher spending towards
healthcare, social assistance programs, expanded employment benefits
etc., amounting to IDR695.2bn (4.2% of GDP), apart from few medium-
term focused measures. To make room for this add-on expenditure, the
budget deficit cap has been temporarily relaxed for 2020-2022, to provide
greater flexibility in responding to the health crisis. Expectations are that
beyond the near-term deterioration, efforts will be made to return to
narrower deficits by 2023 and reinstate fiscal rules. This path is premised
on the pandemic being brought under control and recovery taking root.

Near-term strain on the public books is unavoidable. By October, total

revenues are down 15% y/y on year-to-date basis, while expenditure is up
13.6%, which takes the fiscal deficit to 4.7% of GDP, undershooting the
projected annual shortfall of 6.3% of GDP. Part of this is due to the slow
disbursements towards stimulus measures, which stood at 58% by mid-
November due to administrative capacity constraints and delay in
beneficiary identification. Despite a late year push to accelerate spending,
full-year deficit outturn might be at least 1% of GDP lower than the
projected deficit -6.3% of GDP, suggesting a smaller fiscal boost to growth
than warranted. Regardless, higher deficits will push up borrowings, likely
taking the public debt level to the upper end of 38-40% of GDP in 2020
and 2021 vs 30% in end-2019.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

The government projects 2021 Budget deficit at -5.7% of GDP, hinging on

GDP growth at 4.5-5.5%. Partial spending commitments from the 2020
stimulus program will spill over into 2021, although we don’t expect fresh
measures next year unless growth risks rise materially. Fiscal math will,
nonetheless, contend with revenue weakness as the economy continues
to recover but activity will still below pre-COVID levels. Our expectation
for a pickup in 2021 growth is premised on fiscal expenditure staying on
course next year.

On the financing end, a mix of offshore borrowings (37% of total by

Aug20), IDR bonds is likely to stay as the mainstay. In the first ten months
of the year, domestic banks and Bank Indonesia were the drivers’ seat in
absorbing domestic bond supply. BI agreed to purchase IDR 575trn (3.6%
of GDP) burden sharing in July, which includes bond purchases of IDR
375trn under private placement. As of mid-Nov20, the burden sharing
arrangement, purchases stood at IDR 270trn as well as fund non-public
goods-SME totalling IDR 114.8trn. BI has purchased IDR 72.5trn bond via
the primary market, including through auction schemes, greenshoe and
private placements. Amidst subdued credit demand and liquidity boost –
by mid-Nov20, BI has injected around IDR680.9trn of additional liquidity,
primarily in the form of lower reserve requirements of IDR155tr and
monetary expansion of IDR 510trn – led banks to also increase holdings
of local debt. This more than compensated for tepid interest of foreign
investors who stayed by the sidelines due to IDR volatility and policy
worries i.e. prolonged period of deficit financing as well as central bank
independence. Foreign ownership of outstanding IDR debt eased to
26.4% in Oct20 vs 38.6% in Dec19.

The central bank’s participation in the domestic debt markets is likely to

be scaled back next year, even as domestic participation will dominate
the buyers’ mix. Investors have given the authorities the benefit of the
doubt that debt monetisation in 2020 was temporary and one-off,
allowing return of market forces in 2021 to price debt. Bank Indonesia and
the government has signaled that it will, nonetheless, remain as a standby
buyer in the debt markets, presumably to contain volatility, with investors
likely to watch these developments closely.

Rate cuts hit the final stretch

Bank Indonesia adopted a coordinated policy push, lowering the BI rate

by 125bps to 3.75% year-to-date, boosting liquidity for the banking

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

system, remained an active buyer in the debt markets and partly financing
the government’s fiscal program.

Benign inflation provides ample room for policy rates to be lowered

further, however, policymakers tread into currency vs yield advantage
dilemma hereafter. While policymakers have tapped windows of
opportunity to support growth when IDR stability reigns, the yield buffer
continues to narrow. Policy transmission is also underway, with 10Y bond
yield (generic) easing >200bps vs year high, banks’ base lending rate
drifting down and pullback in the overnight depo facility rate, which has
outdone the 100bps YTD cut in the benchmark rate.

Foreign interests into debt have returned after five months, also drawn
by the 5% quarter-to-date appreciation in the rupiah. A rate cut at this
juncture might, however, diminish the yield advantage. We don’t
anticipate further rate cuts into 2021. However, a sharp increase in the
infection caseload leading to growth risks and strong IDR appreciation are
triggers that might push them to consider further easing.

External balances in a strong shape

Indonesia registered a BOP surplus in 1Q-3Q20 of US$2.8bn on course to

post a second consecutive year of surfeit. Much of this strength is due to
an improved current account balance, driven more by weak inbound
shipments (-17.6% y/y YTD) rather than higher exports. This masked the
deficit in the service account which weakened due to weak tourism

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

receipts, FDI-related repatriation flows, amongst others. Current account

deficit narrowed to -0.7% of GDP in 1Q-3Q vs -2.7% in 2019.

On the financing end, direct investment flows have strengthened beyond

portfolio flows in 1Q-3Q but a pick in late 2020 flows into region should
buttress portfolio inflows in 4Q. For the year, we expect the current
account deficit to narrow to -1% of GDP. Factoring in the likelihood of a
gradual improvement and concomitant pick up in import growth, the CAD
might widen marginally to -1.2% of GDP in 2021.

Laying the ground for a manufacturing and investment push

Into 2021, besides the pandemic, focus will also be on expanding

manufacturing and investment footprint via the recently passed Omnibus
Bill and finalisation of the Regional Comprehensive Economic Partnership
(RCEP) multilateral agreement.

Following the passage of the Omnibus bill (Indonesia: Government bats

for reforms, rate cuts draw a pause) into law, attention will be on
implementation of the regulations and its effectiveness. These reforms
are imperative to improve the economy’s investment appeal amidst shifts
in the global supply chain. This assumes importance for Indonesia’s
longstanding plans to lower reliance on commodities-based shipments
and deepen the manufacturing sector, in turn necessary catalysts for job
creation and formalize the economy.

The sector’s share has been moderating in recent years, hampering the
country’s appeal to gainfully employ its workforce which is amongst the

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

largest vs ASEAN peers, despite relatively favourable basic wages (see

chart). These need to be done in conjunction with improving labour
productivity and skills development, and strengthen its linkage with
wages, which will translate into stable real unit labour costs and higher
profit growth. The Omnibus law aims to address some of the labour
market rigidities (overtime, high severance pay, high proportion of
informal/ casual labour etc.), along with providing a favourable corporate
tax structure and opening sectors to foreign participation.

Apart from higher domestic participation, this will help increase non-debt
creating and stickier foreign direct investments. Compared to the region,
flows into Indonesia have been modest in the last decade. An investment
friendly environment, aided by easier business licensing, clarity on
regulatory frameworks and labour reforms, should help raise higher
foreign direct investments (~2% of GDP), which will also contribute to
financing the economy’s current account deficits.

The Regional Comprehensive Economic Partnership (RCEP) was signed

earlier this month, which includes all 10 members of ASEAN, along with
Australia, China, Japan, New Zealand and South Korea (Macro Insights
Weekly: RCEP is a big deal). As it stands, goods tariffs are not high in the
region, and many Asian economies have existing bilateral free trade
agreements in place. The pact, nonetheless, would harmonise rates and
standards, which would take the region closer toward a coherent trading
zone, turning out to be beneficial for supply chain efficiency, market
access, and investments.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Indonesia, as part of ASEAN, already has several regional trade

agreements that are in force, including with Australia, New Zealand,
China, India, Japan and Korea, apart from the ASEAN FTA. Nonetheless
the economy will seek to deeper integration into the Indo-Pacific bloc, to
gain a larger trade and investment foothold.

For now, the trade dynamics are lopsided as Indonesia run a sustained
trade deficit on aggregate basis, with the bloc members, with China
accounting for majority of the deficit. Part of this is, however, offset by
strong investment flows from the bloc, of which Japan (34% of total RCEP
partners in 2019) and Singapore (26%) are top two investors. Entering the
multilateral agreement against this backdrop, authorities are not only
needed to improve manufacturing productivity, alongside simplify ease of
doing business and infrastructure as well as connectivity, but also lower
tariff and non-tariff hurdles. Indonesian exports stand to gain about
US$13bn in incremental benefits over the coming decade, according to a
study by the Peterson Institute For International Economics (PIIE) (link).

Indonesian rupiah: Stable between 14000 and 15000

The Indonesian rupiah is forecast to be more stable around 14000-15000

per USD in 2021 after a volatile 2020. The IDR plunged 17% to 16625 per
USD in March when the Covid-19 outbreak led to a global shortage of USD
liquidity.

Global financial markets stabilized in late March on the coordinated

monetary policy easing by central banks worldwide. It was, however, the
USD60bn repo facility that Bank Indonesia reached with the Fed in early
April that fueled the IDR’s sharp 22% appreciation to 13870 in 2Q20. Since
then, USD/IDR has settled into a 14000-15000 which we expect will
extend into 2021 in accordance with past consolidation during the early
recovery phase from a global recession.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Global financial crisis COVID-19 pandemic

12 13000 6 17000

USD/IDR 12000 16000

10 (rhs ) 5
11000 USD/IDR 15000
(rhs )
8 10000 4
14000
9000
6 3 13000
8000
12000
4 7000 2
UST 10Y
11000
6000 (%, l hs )
2 1
Fed Funds Rate UST 10Y Fed Funds Rate 10000
5000
(%, l hs ) (%, l hs ) (%, l hs )
0 4000 0 9000
04 05 06 07 08 09 10 11 16 17 18 19 20 21
Sources: DBS Research, Bloomberg data Sources: DBS Research, Bloomberg data

Externally, there is no imminent threat of rising US interest rates next

year. The US Federal Reserve has pledged to keep rates low into 2023 on
its new average inflation targeting framework. Modest volatility can,
however, be expected from a steeper US yield curve when the US
recovery gains traction.

In this conducive US environment, foreign investors are likely to keep faith

in IDR-denominated government bonds which boast the highest yields in
Asia. Like equities, these bonds are an important source of support for the
IDR as evidenced by the sell-off during the coronavirus outbreak in March
and the brief jolt to confidence in 3Q20 from debt monetization and fiscal
slippage concerns.

Since then, investor confidence has improved from positive

developments and a better outlook. Mrs Sri Mulyani was, in October,
named Finance Minister of the Year for East Asia Pacific by the Global
Markets magazine for steering the economy through the pandemic. In
November, the US International Development Finance Corporation has
signed a letter of interest to invest in the country’s sovereign wealth fund.

Indonesia’s investment-grade long-term foreign currency debt ratings,

currently two notches above junk, have been underpinned by a
favourable outlook for 2021-2022. Apart from the return of positive GDP
growth around 4.0-4.5%, inflation is expected to remain benign in the
lower bound of its official 2-4% target amidst more sustainable current
account deficits of about 1-2% of GDP.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Rates: Enjoy the carry conditions

Current conditions are supportive of further gains in IndoGB. Global

liquidity conditions are flush with DM rates generally low despite a burst
of optimism over COVID-19 vaccines. With policy makers unlikely to
withdraw accommodation (and unlikely to signal tightening until late
2021) for some time, the hunt for yield should drive investors into under
owned IDR assets. These favourable conditions have enabled Bank
Indonesia (BI) to cut the policy rate to 3.75%. While we think that BI may
be done with (or very close to) the easing the cycle, rate hikes are not
likely through 2021, supporting Indo govvies in the process. We would
also note that Indonesia’s funding conditions have improved significantly
in the crisis nudged the current deficit to just 1.3% of GDP, the smallest
since 2017.

IndoGB: Std Dev Gap between Yld IndoGB can richen vs UST under carry conditions in
differential & ARVI early 2021
Index bps
800
4.00

3.00 700
10Y average
Yields should
2.00 be higher 600

1.00
500
0.00
400
-1.00

-2.00 Yields should 300 Yield spread of 10Y

be lower IndoGB over 10Y UST
-3.00 200
May-15 May-17 May-19 Aug-10 Aug-13 Aug-16 Aug-19
Source: Bloomberg, DBS Source: Bloomberg, DBS

Our Asia Rates Valuation Indicator (ARVI) suggests that 10Y Indonesia
government bonds are undervalued relative to UST and its other high
yielding peer (India). We think that foreign investors have only just begun
warming up to EM (and Indonesia) assets. To put things into perspective,
Investors are still net sellers of about USD5bn of Indonesia debt this year,
even after accounting for USD2.4bn of net inflows in the fourth quarter.
Foreign ownership of govvies stand at 26% of outstanding, far below the
39% registered in January. Investors have been more wary of BI’s
quantitative measures and the potential negative impact on the rupiah.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Notably, Indonesia USD credit spreads are now close to historic tights
while 10Y local govvie spread over similar tenor UST shows that IDR govies
are close their long-term averages. There is scope for compression if carry
conditions continue into 1Q21. We think indo govvies will generally
outperform peers in the coming few months. Being relatively high
yielding, there should be sufficient cushion even if there is a modest rise
in DM rates. We expect 10Y yields to hover around 6% in 1H.
Subsequently, we are more cautious about a rise in DM rates posing
headwinds to IndoGB and expect modest upward pressures on Indo yields
to materialise.

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Indonesia Outlook 2021: Beyond the pandemic November 30, 2020

Group Research
Economics & Macro Strategy

Taimur Baig, Ph.D.

Chief Economist - G3 & Asia
+65 6878-9548 taimurbaig@dbs.com

Chang Wei Liang Radhika Rao

Strategist Economist – Eurozone, India, Indonesia & Thailand
+65 6878-2072 weiliangchang@dbs.com +65 6878-5282 radhikarao@dbs.com

Nathan Chow Irvin Seah

Strategist - China & Hong Kong Economist - Singapore, Malaysia, & Vietnam
+852 3668-5693 nathanchow@dbs.com +65 6878-6727 irvinseah@dbs.com

Eugene Leow Samuel Tse

Rates Strategist - G3 & Asia Economist - China & Hong Kong
+65 6878-2842 eugeneleow@dbs.com +852 3668-5694 samueltse@dbs.com

Chris Leung Duncan Tan

Economist - China & Hong Kong FX and Rates Strategist - Asean
+852 3668-5694 chrisleung@dbs.com +65 6878-2140 duncantan@dbs.com

Ma Tieying, CFA Philip Wee

Economist - Japan, South Korea, & Taiwan FX Strategist - G3 & Asia
+65 6878-2408 matieying@dbs.com +65 6878-4033 philipwee@dbs.com

Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations).

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