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Market Outlook 2017: Macro backdrop remains positive

Stronger GDP growth driven mainly by consumption

We see Indonesia GDP growth accelerating from 5.1% in 2016F to 5.3% in 2017F driven mainly by higher consumption.  We believe low inflation and interest rate environment coupled with rising commodity prices should help boost purchasing power and enable a further consumption recovery. 2Q16 saw private consumption improve to 5.04% after registering sub-5% growth since 2Q15. We also expect higher investment driven by a robust consumption growth outlook, better political stability, recovery in  exports, and likely further sovereign credit rating upgrades on more realistic budget which can improve the policy to be more effective and predictable.

Expecting inflation to marginally pickup…

In contrast, we forecast a pick-up in inflation from 3.2% in 2016F to 3.9% in 2017F, albeit still historically low, as we expect upside risks relating to food and administered price increases. We see climate irregularities are affecting food prices next year while the government has planned to raise electricity tariff for 900 VA subscribers, driving staple good price hikes. 

…flat benchmark rate and slightly weaker Rupiah

We expect Bank Indonesia (BI) to keep its benchmark rate (7day reverse repo rate) on hold at 4.75% throughout 2017F, as inflation seen to remain picking up and to anticipate Fed rate hike.  The expectation of higher fed rate in 2017 will also lead to weaker Rupiah despite the depreciation won’t be significant where we forecast to depreciate from 13,100/USD at end 2016 to 13,400 at end 2017.

More realistic and credible budget

The government 2017 budget clearly reflects the consolidation effort that has been put in to make it realistic and credible, given the continuing global uncertainties. Contrary to last year when the government overestimated economic growth of 5.3%, it seems that the government now deliberately underestimates economic growth. If the government continues to hard work - and especially if there occurs an improvement in external conditions, the 5.1% growth target for 2017 will most likely need to be revised upward somewhere next year.

Next year, fiscal spending will still be focused on infrastructure, health, education, and social assistance programs. State spending on infrastructure has been significantly increased since 2015. In 2016, spending on infrastructure is estimated to reach Rp313.5 tn (15% of the total state budget). In the 2017 budget, the amount is estimated to increase by 11%, reaching Rp 347 tn (17% of total state budget or 3% of GDP).

It is also more realistic in the sense that, amidst continuing weak global economic conditions and low commodity prices, albeit increased this year, it no longer sets ambitious growth targets like in previous years. The government expects state revenue shortfalls to continue and hence has cut fiscal expenditures for next year. Overall, the 2017 budget projects a soaring fiscal deficit as a consequence of lower-than-expected tax revenue alongside the commitment to maintain spending for national priority programs such as infrastructure and social assistance programs. The government estimates that the budget deficit will reach Rp330 tn, or 2.41% of GDP in 2017.

Indonesia’s fiscal law limits the budget deficit to 3% of GDP and the public debt to 60% of GDP. Given these legal limits, Indonesia still has ample room in which to increase its public debt level, which currently is at 27.5% of GDP, for financing priority programs. Nevertheless, increasing public debt for development purposes should always be managed prudently for the sake of fiscal sustainability.