Boston, MA -- (SBWIRE) -- 10/30/2013 -- Indonesian assets have been hit hard by the confluence of a global flight to the US dollar as well as a record current account deficit and high domestic inflation. Although both the government and central bank have made efforts to stem high levels of volatility, we note that the measures introduced thus far are unlikely to be sufficient, and that tighter monetary policy may still be needed to avert a crisis of confidence. As a result of the hit that rising borrowing costs and inflation will take on investment and private consumption, we have downgraded our 2014 real GDP growth forecast materially from 6.0% to 5.4%.

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Despite the Indonesian government's 44.4% petrol fuel price hike in June, we note that this still entails a substantial fiscal contribution towards inefficient subsidies, going forward. Indeed, while we view the Yudhoyono administration's ability to address the unwieldy subsidies as a positive, we continue to stress that more will need to be done by the next administration. With political risks rising ahead of 2014's general elections, however, the continuation of a reformist government is far from guaranteed.

Major Forecast Changes

Despite a moderation in real GDP growth to 5.9% in Q213, the Indonesian economy continues to expand at a healthy clip. That being said, we believe that headwinds are growing, particularly in view of both tightening monetary policy conditions (which will mean rising borrowing costs) and soaring inflation. As a result, we have lowered our headline 2013 and 2014 real GDP growth forecasts to 5.8% and 5.4% from 5.9% and 6.0%, respectively, and note that both investment activity and private consumption could be set to disappoint through H114.

Further interest rate hikes (in addition to its 125bps worth of hikes since June) are within the realm of possibility in the coming months, and BI will switch gears to an easing stance only when disinflation comes more firmly into play. Additionally, we have downgraded our end 2013 and 2014 rupiah forecasts to IDR11,700/US$ and IDR11,500/US$, respectively, reflecting a neutral stance on the currency based on our expectations for the unit to stabilise over the coming weeks.

Much of the recent volatility surrounding Indonesian assets is attributable to concerns over the country's deteriorating external position, with the current account deficit having stretched to a record US$9.8bn (approximately 4.4% of GDP) in Q213. Despite the fact that recent measures undertaken by the government and central bank, as well as the weakening rupiah, should help to alleviate Indonesia's external imbalances over the coming quarters, we have nevertheless downgraded our 2013 and 2014 current account deficit forecasts to -3.1% and -2.4% of GDP, respectively.

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