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2022 winds up on a strong note

Indonesia’s 4Q22 GDP growth rose 5.0% yoy, narrowly better than consensus but easing from 5.7% in the quarter before. This takes full-year 2022 growth to an average of 5.3% yoy, better than 2021’s 3.7%. By 4Q, headline GDP had exceeded pre-pandemic levels by 7% and consumption by 4%. Exports have seen the largest 30% pick-up vs Oct-Dec19 levels.

Points of note included:

• Better household consumption (4.5% yoy) in 4Q made up for the -5% fall in government demand, besides slowing investment growth and exports 

• As per contribution to headline GDP, consumption slowed by 0.5 percentage points (ppt) compared to the 1Q-3Q average, and investment -0.2ppt fall. The impact of the subsidy price hike, coupled with high inflation, likely hurt households’ purchasing power, despite fiscal cash transfers. The contribution of net exports witnessed the most notable increase as imports slowed to a greater extent than exports. 

• For the year, consumption accounted for nearly half of 2022 output, a quarter by investment growth (buildings & structures, machine & equipment, and vehicles), and ~15% by net exports. The latter was largely driven by terms of trade advantage due to high commodity prices, including coal, palm oil, iron ore, nickel amongst others. 

• Java island contributed to 56.5% of overall growth, growing by 5.3%, largely in line with the past few quarters. Sumatra province was the next, with 22.04% share and 4.7% growth.  

• Under the industry breakdown, non-goods sectors, including transportation and storage, rose 19.9% yoy, followed by accommodation & food services at 12%, trade and manufacturing at around ~5% yoy.

Outlook for 2023

Household spending is likely to normalize this year as few of the tailwinds dissipate, especially reopening dynamic and geopolitical premiums that had lifted commodity prices sharply. Nonetheless, recovery from the pandemic will help, coupled with lagged impact of commodity gains, easing unemployment and service sector restoration, including tourism, besides Lebaran festivities in 2Q. Business sentiments are holding up, with PMIs in expansionary territory and recovery in capacity utilization rates. Credit growth is likely to continue its run, backed by ample rupiah liquidity, as the loan-to-deposit ratio hovers at 81-82%, below pre-pandemic levels, and lending costs are still to reflect rate hikes.

After last year’s spurt, normalization in demand might introduce some caution over aggressive capex spending plans, especially in 2H, as elections are due in 1Q24, while foreign-focused firms eye slowing global growth. The government’s pro-investment bias is expected to help, as a cut in fuel subsidies opens the room for more developmental spending (7% increase in 2023 on infra). With most commodity groups off high in 2H22, we expect these prices to normalize in 2023, but not return to pre-pandemic levels, thus helping to keep the trade balance in surplus. China’s reopening will be another reason to mark a floor for the metals and ferrous commodities, benefiting Indonesia. Overall, we expect growth to average 5% in 2023, returning to the five-year average before the pandemic.

Bank Indonesia to slip into a prolonged pause

January inflation moderated to 5.3% yoy vs 5.5% in Dec22. The outcome validated the BI’s expectation that price pressures have eased, and readings are likely to moderate over the next few months. Core inflation also eased to 3.3% yoy from 3.4% the month before. Energy inflation and administered readings eased to 15.3% and 12.3%, respectively, while volatile (supply-driven) ticked up gradually to 5.7% (vs 5.6% in Dec22).

Looking ahead, administered prices are unlikely to be adjusted higher in a pre-poll year, whilst food costs might edge up ahead of the April festivities, largely on a seasonal impact. Headline prints are expected to return to the 2-4% BI inflation target by 2H, when subsidy cuts had pushed up inflation in the comparable year before. The evolving trend prompts us to trim our inflation forecast to 3.7% yoy vs 4% previously.

After delivering the 25bp hike in January along our expectations (Indonesia: Approaching tail end of the hike cycle), Governor Perry dropped a strong hint that cumulative 225bp rate hikes in this cycle (3.5% to 5.75%) were ‘adequate’ to ease inflation back towards the target range. With the US FOMC commentary on 1-Feb also cementing expectations that a peak in the US rates is in sight, the current BI rate (5.75%) is already above the priced-in US terminal rate (of 5%).

Lastly and most importantly, after underperforming the regional currencies in Nov-Dec22, the rupiah has strengthened sharply in Jan23 to date, tracking the drop in the broader dollar index.

Currency outperformance and a resumption of foreign flows into the debt markets bode well for macro stability, backstopping the decision to pull the brakes on the hike cycle. Rates likely peaked at 5.75%, leaving real rates in positive territory. Additionally, as central bank policy works with a lag, hence a pause at this juncture will also be based on the growth-inflation mix down the next 2-3 quarters. We revise our call for BI to keep rates steady for rest of the year, in line with inflation-growth pivot.

Meanwhile, the BI also outlined details on the new foreign currency term deposits for export proceeds for tenors of one to three months. As banks will not be allowed to use these FX funds for onward lending, they will enjoy a special dispensation whereby these deposits will be excluded from reserve ratios. A requirement might be added to keep these FX earnings for three months. This move will boost domestic FX liquidity and bridge the significant yawn between offshore vs domestic returns on such deposits. 

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