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Analysis: Stronger rupiah ahead on low oil prices
For now, Indonesia is not benefiting from the current low oil-price environment due to the governmentâs recent move to raise domestic fuel prices
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For now, Indonesia is not benefiting from the current low oil-price environment due to the government's recent move to raise domestic fuel prices. Instead, November inflation was up 1.5 percent month-on-month (mm) ' 6.23 percent year-on-year (yoy) ' from this price shock, considerably higher than our estimate of 1.15 percent and slightly higher than the market estimate of 1.41 percent (Table 2).
The higher mm figure brought year-to-date inflation to 5.75 percent, which was also pushed up by higher staple food prices and transportation costs.
On core inflation, the November figure also rose 0.4 percent mm, higher compared to the October level of 0.27 percent, due to the indirect impact of rising fuel prices, including urban transportation costs and airline tickets. The mm figure translates into an annual level of 4.21 percent yoy (October: 4.02 percent).
Nevertheless, Indonesia should benefit from medium-term structural changes in oil prices, in our view, which are caused by several supply-demand factors.
First, China's economic outlook appears bleak, with most international institutions, including the World Bank and the International Monetary Fund (IMF), expecting lower gross domestic product (GDP) growth. Weak European economies have also dragged down global demand.
Second, in terms of global supply, significant shale gas production in the US has raised the country's oil-production capacity to around 9 million barrels per day (bbl/day) compared to 5.5 million-6 million bbl/day three years ago (Table 3). This increased production should apply greater pressure to oil prices. In fact, apart from declining Chinese demand, we are of the view that the behavior of US oil producers will be a major factor in determining long-term oil prices.
Third, we believe the recent Organization of Petroleum Exporting Countries (OPEC) decision to refrain from cutting oil-supply quota may be a strategy to challenge rising US oil production. In sum, while we believe the recent decline in oil prices will not be sustained over the longer term; we now expect the Brent oil price to dip to US$60 per barrel (previous estimate: $95) as of the end of 2014, before gradually rising to $78 per barrel (previously $93) as of the end of 2015 (Table 1).
Looking ahead, the 2015 consumer price index (CPI) may be better than expected if President Joko 'Jokowi' Widodo caps the fuel-subsidy amount at a certain rupiah per liter, allowing subsidized-fuel prices to move in line with the rupiah and the Brent oil price (floating scheme).
With the downtrend in global oil prices, the public would benefit by directly taking advantage of declining fuel prices. This type of scenario is not likely to occur under the current fixed fuel-price scheme. We plan to revisit our 2015 CPI target of 5.6 percent (2014: 7.5 percent) if the government were to decide to implement a floating fuel-price scheme.
On the trade front, October imports slightly contracted 1.40 percent mm (September: 5.09 percent) to $15.3 billion (Table 2), mainly stemming from a decline in non-oil and gas imports such as machinery, steel and plastics. This occurred as domestic manufacturers' demand for raw materials declined.
October imports led the figure from this year's first 10 months to contract by 4.06 percent yoy to $149.7 billion.
Exports slightly rose 0.49 percent mm on higher crude palm oil (CPO) exports: In line with our expectations, October exports reached $15.4 billion, slightly up 0.49 percent mm (-2.21percent yoy), supported by a rise in palm-oil exports and helped by reduced export taxes amid lower global CPO prices. Nevertheless, October exports still slowed 2.21 percent yoy, bringing the first 10 months' figure to US$148.1 billion, down 1.06 percent yoy.
The January-October trade deficit of US$23 million helped by improving exports: In sum, the better-than-expected October trade balance of a $23-million surplus was largely in line with our expectations, helped by improvement in exports coupled with lower imports. This brought the January-October trade deficit to $1.6 billion, slightly lower than the January-September level of $1.7 billion (Table 8).
Given these developments, we forecast the 2015 average Brent oil price to drop to $71.4 per barrel, paving the way for the current account deficit (CAD) to improve, as we estimate oil imports would decline by $7.4 billion. However, a lower oil price would also pull down other commodity prices, including CPO and coal. In sum, we believe the overall impact should be positive on Indonesia with the country's 2015 CAD expected to improve to 1.95 percent of GDP (previous estimate: 2.7 percent), before further narrowing to 1.50 percent of GDP in 2016 (previously 2.4 percent).
Fundamentally, an improvement in the CAD would likely strengthen the rupiah against the US dollar. Hence, we lower our 2015 year-end currency target to Rp 11,500 per US dollar from Rp 11,700 and expect the rupiah to continue to appreciate to Rp 11,200 per US dollar in 2016 (previous estimate: Rp 11,500).
Note that this is even after our assumption that the central bank would continue to build its foreign-exchange reserves to higher levels in order to prepare for capital outflows given the US Federal Reserve's possible decision to raise interest rates in 2015.
As we expect Indonesia's external trade balance to remain solid, we think our stronger rupiah target is conservative at this stage.
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The writer is an economist for the research department of Bahana Securities.
