Indonesia is entering a new low-inflation regime with October inflation at 0.14 percent month-on-month (mom) or 3.31 percent year-on-year (yoy). This compares with Bahana Securities and consensus’ forecast of 0.12 percent mom. The low inflation was supported by continued deflation in prices of staple foods at -0.21 percent mom (compared with -0.07 percent mom in September), clothing at -0.31 percent mom (0.13 percent mom in September) and transportation at -0.03 percent mom (0.19 percent mom in September).

Processed foods inflation was still low at 0.24 percent mom (0.34 percent in September), as well as education inflation at 0.1 percent mom (0.52 percent mom in September) and healthcare at 0.29 percent mom (0.33 percent mom in September), although housing-related inflation was slightly up at 0.56 percent mom.

The interesting point is that core inflation continued its downward trend at 3.08 percent yoy (compared with 3.21 percent yoy in September), supported by the rupiah’s appreciation.

Region-wise, 34 out of 81 cities reported deflation (exhibit 1) with 21 of them (62 percent) from outside Java and Sumatra.

In our view, the recent price drops in the eastern parts of Indonesia suggest emerging structural improvement in the country’s distribution and infrastructure. Note that Sorong, Tanjung and Palu saw the highest deflation at -1.1 percent, -1.08 percent and -0.95 percent mom respectively.

At the wholesale level, general non-oil and gas wholesale price index (WPI) inflation in October was at -0.20 percent mom (compared with 0.52 percent mom in September), backed by lower non-oil and gas export price at -1.32 percent mom (from 1.97 percent mom in September), while non-oil and gas import price only slightly decreased -0.01 percent mom (from 0.18 percent mom in September).

On the domestic front, agriculture prices slightly increased 0.02 percent mom (compared with 0.24 percent mom in September), while the mining price index was at 0.24 percent mom (from 0.37 percent mom in September) with the manufacturing price index at -0.02 percent mom (compared with 0.27 percent mom in September).

Indonesia’s October Markit PMI (Purchasing Managers Index), which is an indicator for manufacturing activities, dropped to 48.7, with drops in new export orders, new orders, output and employment (exhibit 2), due to unfavorable weather conditions.

Markit also reported that even though prices are increasing, the average rate of inflation is still below the long-run average level and they expect the recent interest rate cut by BI to have a positive impact on manufacturing activities at year end.

On a year-to-date basis, October inflation was low at 2.11 percent with core inflation at multi-year lows (exhibit 3).

Looking ahead, inflation is likely to be stable at low levels as the government continues to pursue policies favoring structural improvements on the supply side.

The risk from the electricity subsidy removal next year will be quite low as the October electricity increase did not affect inflation much with staple prices remaining manageable. For November, last year’s low base means that our inflation forecast of 0.3 percent mom would translate to 3.4 percent yoy inflation.

Therefore, we retain our year-end inflation forecast at 3.3 percent yoy and 2017’s year-end inflation at 3.8 percent yoy. Better inflation dynamics and an improving external balance should provide room for BI to cut the benchmark interest rate by 25 basis points in the upcoming November meeting.

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The writer is an economist at Bahana Securities.

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