February 2014

Global Economics

Tuuli McCully 1 (416) 863-2859

Executive Briefing
tuuli.mccully@scotiabank.com
INDONESIA

Capital Market Dynamics

Foreign Exchange ► The Indonesian rupiah (IDR) is subject to persistent depreciating pressure on the back of
US dollar (USD) strength, as well as Indonesia’s weaker economic fundamentals, including the large current
account deficit, high inflation, and political uncertainty. This has prompted authorities to intervene in the currency
market, and to implement various measures to release pressure on the country’s current account (such as curbing
imports and tightening monetary policy). Foreign exchange reserves (currently at US$101 billion) have recovered
somewhat in the past few months, but they remain below the level at the end of 2012. We expect the IDR to close
2014 at 12,500 per USD, implying a further 3% depreciation this year after a 20% loss in 2013.
Sovereign Debt & Credit Ratings ► Investor perceptions of Indonesia’s sovereign credit risk, as measured by
the cost of insurance of government bonds, have stabilized somewhat in recent months. The country’s 5-year
credit default swaps (CDS) hover below the six-month average level of 230 basis points (bps) compared with a
peak of over 300 bps in August. The nation’s current long-term foreign currency ratings are as follows: Moody’s:
“Baa3”, Standard &Poor’s (S&P): “BB+” and Fitch: “BBB-”, with S&P being the only agency not ranking Indonesia
in the investment-grade category. Nevertheless, S&P acknowledges that the country’s rating constraints are
balanced by relatively healthy government finances, prudent fiscal policies, and sound economic growth outlook.
Economic Outlook
Growth ► Indonesia’s real GDP growth remains strong by regional standards through 2015. The country’s output
advanced by 5.7% y/y in the final quarter of 2013 following a 5.6% gain in the July-September period, taking
expansion to 5.8% for the year as a whole, in line with the average growth over the past 10 years. Momentum
continues to be driven by household spending, as indicated by solid consumer confidence and retail sales data.
While investment activity is slowing, government spending will likely underpin economic performance on the back
of pre-election outlays; this, combined with a gradually recovering export sector, will likely translate into an
average real GDP gain of 5.7% in 2014-15.
Inflation & Monetary Context ► A monetary tightening bias will remain in place in Indonesia. The reference rate
was raised by 175 bps between June and November to the current level of 7.50%, and another small increase
may take place in the coming months. Tighter monetary conditions will help limit inflationary pressures and
stabilize the Indonesian rupiah, which has faced a persistent weakening bias in recent months. Nevertheless,
annual inflation will likely continue to exceed the central bank’s target corridors, which are set at 3½-5½% for 2014
and 3-5% for 2015. Consumer price inflation closed 2013 at 8.4% y/y, up from around 5.5% in the first half of the
year, reflecting a cut in fuel subsidies. We expect inflation to hover at 6½% y/y at the end of this year.
Fiscal & Current Account Balance ► Public finances are relatively healthy, with gross government debt set to
average 27% of GDP in 2014-15. Nevertheless, Indonesia suffers from a fairly low fiscal revenue base,
constraining public investment spending and leaving infrastructure development needs unattended. The recent
fuel subsidy reform will ease the burden on government finances. The fiscal deficit, as measured by the general
government’s net borrowing ratio, will likely average 2⅓% of GDP in 2014-15. Indonesia’s weaker external
position continues to be a concern for the country’s policymakers. While the income deficit continues to widen,
better export sector performance will improve the trade account only gradually; accordingly, we expect the current
account shortfall to average 2.8% of GDP through 2015.
Institutional Framework & Political Environment
Governance ► General elections will be held in April 2014, followed by a presidential vote in July. The revival of
economic nationalism that aims to limit the involvement of foreign mining companies in resource development will
likely continue. Quality of governance remains fairly weak: Indonesia ranks 114th (out of 175 countries) in
Transparency International’s 2013 Corruption Perceptions Index, down from the 100th rank in 2011. Meanwhile,
the World Economic Forum’s 2013-2014 Global Competitiveness Index positions Indonesia fairly favourably, at
38th out of 148 countries, citing that after years of inattention, infrastructure spending has started to bear fruit.
Financial Sector ► Indonesia’s banking system is well-capitalized, with the Tier 1 Capital ratio at 16.3% in the
third quarter of 2013, according to the International Monetary Fund. Asset quality remains high; the banking
sector’s non-performing loans ratio is 1.8%. Fast credit growth warrants continued vigilance by Indonesian
authorities: lending increased by 22% y/y in November.

Executive Briefing is available on scotiabank.com and Bloomberg at SCOT

 February 2014
Global Economics
Executive Briefing

INTERNATIONAL ECONOMICS GROUP

Pablo F.G. Bréard, Head Daniela Blancas Sarah Howcroft Tuuli McCully Estela Ramírez
1 (416) 862-3876 1 (416) 862-3908 1 (416) 862-3174 1 (416) 863-2859 1 (416) 862-3199
pablo.breard@scotiabank.com daniela.blancas@scotiabank.com sarah.howcroft@scotiabank.com tuuli.mccully@scotiabank.com estela.ramirez@scotiabank.com

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