Inflation: Higher in August, lower in subsequent months

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On the back of Lebaran-related activities, August Consumer Price Index (CPI) soared to 0.95 percent month-on-month compared to July’s level of 0.7 percent, translating to year-on-year CPI of 4.58 percent, slightly higher than July’s 4.56 percent due to increases in staple food, clothes, education and transportation prices. August figure was higher than our estimate of 0.68 percent month-on-month and consensus’ expectation of 0.8 percent.

August core inflation surged to 0.97 percent month-on-month, much higher than previous month of 0.53 percent, propelled by transportation and recreational costs during Lebaran. Additionally, education costs also increased in the new academic year. However, on a year-on-year basis, core inflation declined to 4.16 percent on lower base effect (exhibit 1).

Although August inflationary pressure was elevated on seasonality, we believe this is temporary in nature. We expect CPI to ease in the remaining months this year as global uncertainties will continue to slow commodity/energy prices in general. Hence, we still believe CPI will decelerate to 4.1 percent year-on-year at the end of this year, in line with BI’s target of 3.5 – 5.5 percent. Thus, we expect BI to hold its benchmark rate at 5.75 percent, unchanged throughout this year.

Although still falling 7.3 percent year-on-year, July’s export of US$16.2 billion improved compared to last month’s drop of 16.6 percent year-on-year, helped by 50 percent month-on-month jump in CPO exports. On the flip side, July exports still suffered from lower demand of mineral fuels, rubber, electrical and mechanical machineries. This translated to 2.5 percent year-on-year contraction in Indonesia’s 7M12 exports.

On the import front, we saw some easing in July to $16.3 billion, down 0.8 percent year-on-year, but still translated to 7M12 import growth of 13 percent year-on-year. As a result, trade deficit reached $0.2 billion in July (exhibit 3), but lower compared to previous month deficit of $1.3 billion, bringing 7M12 external trades to experience a surplus of $330 million.

On further pressure coming from declining exports, we expect widening current account deficit ahead, resulting in continued pressure on our local currency. At this stage, we have assumed weaker currency and moved our year-end 2012 rupiah target to 9,450/$1 from 9,150/$1 previously. However, we still expect some rupiah strength in 2013 to 9,250/$1 on strong investments.

As widening current account deficit will result in higher demand of dollars in the domestic financial market, BI will continue to maintain rupiah stability through intervention which would bring down foreign exchange (FX) reserves going forward. Hence, we revise down our 2012 FX reserves to $102 billion (still sufficient to cover six months of imports) from $117 billion previously.

The writer is an economist at PT Bahana Securities.