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Analysis: Biggest challenges: Inflation and external trade deficit
Relatively in line with our estimate but slightly higher than market expectations, the August Consumer Price Index (CPI) declined to 0
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Relatively in line with our estimate but slightly higher than market expectations, the August Consumer Price Index (CPI) declined to 0.47 percent month-on-month (m-o-m) as compared to 0.93 percent in July, mainly supported by lower prices of staple foods, clothing, health services as well as transportation costs (exhibit 3) post the Idul Fitri festivity.
Inflation declined to 3.99 percent in August year-on-year (y-o-y) ' the lowest level in 29 months ' from July's level of 4.53 percent. Additionally, we also note that the August CPI reached 3.42 percent year-to-date (exhibit 2). In terms of core inflation, the August figure, in line with our expectations, slowed to 4.47 percent y-o-y, compared to 4.64 percent in July, on the back of lower inter-city transportation tariffs and cell-phone prices.
Despite a relatively benign CPI at present, we expect escalating inflationary pressure ahead due to adjustment on administered prices as follows:
First, as the new government will have limited fiscal space to accommodate its own programs, we expect the new administration to raise subsidized fuel prices in the fourth quarter of 2014 (2014 Q4) to ease fiscal pressure and provide greater flexibility. Assuming both subsidized Premium gasoline and subsidized diesel prices are raised by Rp 2,000 per liter, our sensitivity analysis shows that this year's CPI will increase to around 9.9 percent y-o-y, up 4 percentage points from our base of 5.9 percent.
Second, the outgoing government has proposed a lower electricity subsidy to Rp 72.4 trillion (-30.3 percent) in the 2015 state budget, suggesting that there will be higher electricity tariffs ahead. No further details have been disclosed thus far. The 2015 state budget is still being discussed in the legislature.
Third, the government has approved state-owned oil and gas company Pertamina's plan to raise the 12-kg Liquid Petroleum Gas (LPG) price. However, details of the tariff hike and timing have not been decided. If Pertamina were to raise the 12-kg LPG price by 14.4 percent, we would expect the CPI to increase 0.14 percent.
On the external trade reading, much lower than our and the street's estimates, July's imports contracted 10.5 percent m-o-m (-19.3 percent y-o-y) to US$14.1 billion (exhibit 2), mainly due to slower business activity during the Idul Fitri holiday. Additionally, imports reached US$104 billion in the first seven months of this year, down 7.0 percent y-o-y.
Also beyond our expectations and those of general consensus, July's exports decreased to $14.2 billion, an 8 percent drop m-m (-6 percent y-y), due to lower offshore demand for domestic electrical machinery, rubber and jewelry. Moreover, July's overall exports brought total exports during the first seven months of this year to $103 billion, down 3.0 percent y-y on relatively mixed economic recoveries across the globe.
Despite a slight surplus of $124 million in July, which was better than our and market predictions, the Jan.-July external trade balance still booked a deficit of $1 billion, slightly lower than the first-half level of $1.1 billion (exhibit 5).
Going forward, we believe rising inflationary pressure and relatively stubborn external trade deficit will be the new administration's main challenges in maintaining the macroeconomic stability of Indonesia.
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The writer is an analyst at the research department of PT Bahana Securities
