2013 Outlook

In do n esi a | M yan m a r | P h ili pp in e s | Th ai la nd

2013 Country Outlook: Indonesia

Research Team  Current account deficit to shrink; GDP growth to see slight uptick
 Bank Indonesia looks to be less tolerant of a weak rupiah in 2013
Brian Sheley
Managing Director  Monetary policy to tighten on inflationary pressures
bsheley@cascadeasia.com  Fuel subsidy reductions possible

Andhika Suryadharma  President SBY vying for post-presidential influence

Senior Market Strategist  Presidential field looks weak but dark horse candidate possible
asuryadharma@cascadeasia.com
 Presidential candidate nominating threshold ruling out this year
Febrio Kacaribu, PhD  Low expectations for policy making in 2013
Senior Economist
fkacaribu@cascadeasia.com
 Expecting JCI to reach 4,550 with a mixed outlook

Cascade Asia Forecast:

Q1 Q2 Q3 Q4 2013 2014
Real GDP (%, y/y) 6.2 6.3 6.6 6.5 6.4 6.3
CPI (%, y/y) 5.3 5.5 6.1 6.0 5.7 5.3
Trade Balance (% of GDP) -1.8 -2.0 -2.0 -2.2 -2.0 -2.4
Policy Rate (%, eop) 5.75 5.75 6.00 6.00 6.00 6.00

Economic Outlook

Current account deficit to shrink; GDP growth to see a slight uptick

Indonesia’s domestic consumption and consistently strong investment
climate have offset its export slump and kept it sheltered from slower global
growth. Consumption will have a tailwind this year with increased spending
by political parties and higher minimum wages and will continue to serve as
a buffer against slow global growth. FDI grew by 23% y/y in 2012 and with
an improving global economy we think Indonesia will be able to sustain
strong foreign investment inflows in 2013.
While its current account is at an estimated 2.4% deficit, we expect strong
Cascade Asia Advisors export demand from Japan, which unveiled a new US$116bn stimulus
PO Box 51194 package, to be a boon for Indonesia’s stubborn current account deficit. We
Seattle, WA 98115
also see improved export demand from the US which is showing some
info@cascadeasia.com
www.cascadeasia.com signs of recovery. Those exports gains may be at least partially off-set

Copyright © 2013 Cascade Asia Advisors. All Rights Reserved. Page 1

though depending on what happens in China this year. Indonesia also imposed a number of
import restrictions in 2012 but we expect resilient consumer demand to sustain and even
surpass existing import levels, largely eclipsing any negative policy impact.
We think commodity prices have mostly bottomed out and are likely to begin recovering with a
marginally improved global environment in 2013. Overall, we forecast 6.4% GDP growth based
on solid macroeconomic fundamentals, sustained foreign investment and robust domestic
consumption. If the government were able to fast-track portions of infrastructure spending
under its infrastructure master plan (MP3EI) this year, growth could reach as high as 6.8%, but
this is not our base case.

Bank Indonesia looks to be less tolerant of a weak rupiah in 2013

The rupiah depreciated roughly 7% in 2012 and was one of the worst performing currencies in
Asia last year but Bank Indonesia’s accumulation of more foreign reserves is a sign that it may
be less tolerant of a weak rupiah in 2013. Foreign exchange reserves stood at USD 112bn in
December 2012, gaining each month for the past seven months, a trend we expect to extend
into 2013. We further expect Bank Indonesia to contain appreciation of the rupiah as it targets
a current account deficit of 2% of GDP. Therefore, the most likely path for the rupiah in 2013 is
a slight appreciation against the USD to the tune of 9500 by the end of 2013.

Fuel subsidy reductions possible

There is chatter of a 33% fuel price hike in April 2013 but the likelihood of a subsidy reduction
that high prior to the election is slim, to say nothing of a full-fledged fuel subsidy reform. The
most likely pathway to fuel subsidy reform in Indonesia will be incremental versus one
sweeping policy reform which would risk bringing the contentious issue to a head, an
unpalatable scenario for the ruling party, particularly with an election right around the corner.
Any level of subsidy reduction though would increase inflation in an already high inflationary
environment.

Monetary Policy Outlook

Monetary policy to tighten on inflationary pressures

There will be added inflationary pressures from stronger domestic demand in 2013 on the back
of higher disposable incomes for those working in the formal sector due to the minimum wage
hike as well as substantial spending by political parties. Combined with the 15% increase in
electricity prices, we expect inflation to increase in 2013 to the tune of 5.4%, still within Bank
Indonesia’s inflation target band, but much higher than in 2012.

Copyright © 2013 Cascade Asia Advisors. All Rights Reserved. Page 2

We expect Bank Indonesia to tighten monetary policy in 2013 but to hold any policy rate
increases until Q3 or Q4 to ease pressure on the rupiah. We anticipate a 25bps increase to 6%
in H2 to ease inflationary pressures. Bank Indonesia will continue to contain consumer
demand through the loan-to-value regulations which we think have had mixed results, effective
on the low end of socio-economic scale but having minimal impact on the spending habits of
middle to higher income classes. Bank Indonesia will need to deploy other tools from its
monetary policy tool kit by adjusting the overnight deposit (Fasbi) rate in H1 2013 to relieve
inflationary pressure in the short term and increasing upward pressure on the rupiah.

Political Outlook

President SBY vying for post-presidential influence to the detriment of sound

leadership
President Susilo Bambang Yudhoyono (SBY) is facing the end of his second term and unable
to run again. However, following a parade of senior Partai Demokrat members who are either
convicted or undergoing trial for corruption, there is no one within the president’s inner circle
with the household name and requisite party support to conceivably make a bid for the
presidency in 2014. Instead, the president is searching for other options for continued
influence. This will not bode well for political appointments and policy making during his
remaining time in office. If the president were to reshuffle his cabinet to replace any of his
ministers this year we would see to what extent he is opening his inner circle and gain insight
into his priorities during his final year. We are not optimistic and do not expect many pro-
market and pro-reform overtures by the president or his cabinet in 2013 and would be
unsurprised by further protectionist policies and market distortions.

Presidential field looks weak but dark horse candidate still possible
Indonesia’s political temperature in 2013 will approach fever pitch with the run-up to
presidential election set for July 2014 and a run-off in September. Parliamentary elections are
scheduled for April 2014. 2014 has long been in the cross-hairs for Aburizal Bakrie, the Golkar
Party chair and the party’s official candidate for president and Gerindra Party Chair,
businessman, and once general Prabowo Subianto, has clear aspirations for the top office.
Former one-term president and PDI-P chair is also positioning her party for a bid at the
presidency. However, they, like other possible contenders, are prominent players in
Indonesia’s patronage system and are not likely to have a credible reform agenda at a time of
high disenchantment among the electorate.
There is at least a conceivable chance that a reform candidate may yet emerge. If anyone, the
dark horse candidate would be Joko Widodo, the Governor of Jakarta who has tremendous

Copyright © 2013 Cascade Asia Advisors. All Rights Reserved. Page 3

political momentum and is garnering a healthy following in Jakarta to compliment a dedicated
cadre in Solo (where he served as Mayor). He has only just embarked upon establishing
himself as a household name but the fact that his would-be presidential contenders have
sought to court him and others to discredit him indicates that he is indeed a formidable option.

Presidential candidate nominating threshold ruling out this year and will shape election
Parliament has yet to finalize the Presidential Election Bill which has been bogged down for
months with wrangling over the presidential nominating threshold. Currently the threshold is
set at 20% of seats in Parliament or 25% of the national vote garnered in the legislative
elections before a party can officially nominate their candidates, but this is still being debated.
It will be unlikely that the composition of any presidential ticket will be known until May 2014
when the official results from the legislative election are released and parties know their
relative strengths and their eligibility to field a candidate. Although a lower nominating
threshold was put forward by smaller parties we think Indonesia’s patronage system will win
the day and ultimately favor the higher threshold, thus successfully instilling artificially rigorous
eligibility requirements to avoid new competition.

Low expectations for policy making in 2013

Indonesia’s parliament remains largely corrupt, widely discredited and almost wholly
ineffective. That will not change in 2013 as we expect a continuation of the poor quality of
legislation that we saw in 2012. Parliament’s legislative agenda for 2013 contains 70 bills,
spanning geothermal energy and revisions to the oil and gas law to banking and review of the
corrupt crimes laws. Combined with the 31 unfinished bills from this year and presidential and
parliamentary elections looming in 2014, we expect the 2013 legislative cycle to be an
unproductive one with not all of those bills seeing floor time. We see the net impact of the 2013
legislative cycle set to be a slight dialing back of democratic reforms and causing investor
confusion. We think a revision of the corrupt crimes law puts the independence of the Anti-
Corruption Commission (KPK) at risk while we expect a review of the oil and gas law to cause
more confusion than provide needed clarity.

Market Outlook

Expecting JCI to reach 4,550 with a mixed outlook

We maintain a relatively positive outlook for the JCI in 2013 amid sound macroeconomic
fundamentals, consistently strong domestic consumption, high foreign direct investment and
an improving infrastructure development environment. Combined with a continuation of the
Fed’s QE3 into 2013 and beyond and the ECB’s European Stability Mechanism now in force,
we do anticipate an improved, if only marginally, global backdrop and with it, Indonesia’s ability
Copyright © 2013 Cascade Asia Advisors. All Rights Reserved. Page 4
to hedge weakness in its current account balance. Foreign holdings remain high and cautious
of policy uncertainty in the lead up to the elections. We also note the potential for a delayed
fuel price hike and thus a higher budget deficit. Market valuations do allow some room for
potential upside. We expect a modest rise in the JCI to 4,550 points, offering a potential upside
of 6% and implying 2013 PE of 14x.

Cascade Asia Advisors is a risk assessment and strategic advisory firm focused on Southeast
Asia. We combine quantitative and qualitative analysis with rich perspective to render convoluted
information into actionable intelligence and uncertain environments into navigable terrain. Our
specialized focus is monitoring and assessing what drives political, macroeconomic and financial
market developments in frontier and emerging markets in Southeast Asia and how they impact
organizations. Our clients find more prosperous market opportunities, modify their business
planning with sharper focus and face challenges with greater clarity and confidence. We help
organizations understand, adapt and prosper in the Pacific Century.

DISCLAIMER
This document is for distribution only as may be permitted by law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident
of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject
Cascade Asia Advisors to any registration or licensing requirement within such jurisdiction. It is published solely for information purposes; it is not an advertisement nor is it a
solicitation or an offer to buy or sell any financial instruments or to participate in any particular trading strategy. No representation or warranty, either express or implied, is
provided in relation to the accuracy, completeness or reliability of the information contained in this document (‘the Information’), except with respect to Information concerning
Cascade Asia Advisors. The Information is not intended to be a complete statement or summary of the securities, markets or developments referred to in the document. Any
opinions expressed in this document may change without notice and may differ or be contrary to opinions expressed by other business areas of Cascade Asia Advisors.

Nothing in this document constitutes a representation that any investment strategy or recommendation is suitable or appropriate to an investor’s individual circumstances or
otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making investment decisions.

Copyright © 2013 Cascade Asia Advisors. All Rights Reserved. Page 5