HIGHLIGHTS

July 2018 BI meeting

• Bank Indonesia kept its 7-day Reverse Repo Rate (7DRRR) at 5.25% after the 100bp increase in May-June.
• BI sees the weaker net export position as a drag on overall economic growth outlook.
• Monetary policy remains biased towards tightening stance amid global uncertainties from US Fed monetary policy normalisation and trade wars.
• The policy focus on rupiah stability implies economic growth would be less likely to get support from monetary policy, at least through 2019F.

Hitting the pause button after 100bp hike…
Bank Indonesia (BI) decided to leave its 7-day Reverse Repo Rate (7DRRR) unchanged at 5.25% after having raised the policy rate by 100bp in May-June. The decision was in line with our and Bloomberg consensus expectation. The Deposit Facility Rate and Lending Facility Rate were maintained at 4.50% and 6.00%, respectively.

… as downside pressure on rupiah subsides
The move came amid some softening of the downside pressure on rupiah. Since the last BI Board of Governors’ meeting, which saw a larger-than-expected increase of 50bp on the policy rate, more attractive yield spreads have reduced the pace of foreign portfolio outflows in the bond market. The weakening of the rupiah was relatively in line with the depreciating trend seen among regional currencies on the back of broad US$ appreciation. The large trade surplus in June also came to its rescue, alleviating pressures on the current account deficit (CAD). We expect higher tourist receipts from the Asian Games as well as the authorities’ plans on import reduction to prevent further deterioration in Indonesia’s CAD position (CIMB forecast: 2.5% of GDP in 2018).

GDP growth restrained by weaker net export position
Given Indonesia’s weaker net export position, the central bank now envisages that the outlook for 2018 economic growth is settling at the lower end of its forecast of 5.1-5.5% (CIMB forecast: +5.3% yoy). BI nonetheless noted a build-up in growth momentum in 2Q18, backed by household consumption and solid investment. Policy coordination between BI and the government has kept inflation rate within the 2.5-4.5% target range, with headline inflation under control during the Lebaran festive month (+3.1% yoy in June).

Monetary policy direction remains biased towards tightening stance
We expect the monetary policy to be guided by external risks, given the US Federal Reserve’s monetary policy tightening cycle and escalating global trade tensions. Indonesia’s trade-to-GDP ratio is low relative to its peers i.e. Malaysia, Singapore and Thailand, insulating the economy from the direct economic impact of US-China trade tensions. Nonetheless, given Indonesia’s higher foreign holding of government bonds and CAD position, rupiah will bear the burden when escalating trade wars trigger flight to safety. Hence, we see Indonesia’s monetary policy direction remaining biased towards tightening stance. The policy focus on rupiah stability implies that economic growth would be less likely to get support from monetary policy, at least through 2019F. We maintain our policy rate forecasts of 5.25% for 2018F and 5.75% for 2019F.

Originally published by CIMB Research and Economics on 20 July 2018.

HIGHLIGHTS

June 2018 consumer price inflation

• Both headline and core inflation decelerated sharply in June (+0.8% yoy and +0.1% yoy, respectively) following the zero-rating of GST on 1 June.
• All but transport components saw falling price gains. Transport inflation accelerated despite unchanged RON95 and diesel prices, due to lower base effect a year ago.
• Benign food inflation can also be attributed to the Price Control Scheme for Aidilfitri 2018, which took effect on 8-22 June.
• We maintain our 2018F inflation forecast of 1.3%, and Overnight Policy Rate (OPR) at 3.25%.

Inflation eases in all key components, but…
The reduction of Goods and Services Tax (GST) from 6% to 0%, effective 1 June, has resulted in a drastic deceleration in both headline and core inflation. The headline inflation eased more than expected to 0.8% yoy in June (CIMB: +1.1% yoy, Bloomberg consensus: +1.3% yoy, May: +1.8% yoy), the smallest increase since Feb 2015, whereas core inflation moderated to 0.1% yoy (+1.5% yoy in May). On a seasonally-adjusted basis, headline CPI fell 1.2% mom in June (+0.2% mom in May).

… lower base effect lifts transport inflation
All key components saw falling price gains, except for the transport component. Transport inflation quickened to 5.5% in June (+3.8% yoy in May) due to rising fuels and lubricants inflation (+10.2% yoy vs. +5.3% yoy in May) and passenger airfares (+3.7% yoy vs. +2.4% yoy in May) as a result of lower oil prices last year. Meanwhile, Price Control Scheme for Aidilfitri 2018, which took effect on 8-22 June, also contributed to benign food inflation (+0.8% yoy in June vs. +2.2% yoy in May) alongside the GST effect.

10% sales tax and 6% services tax to be reintroduced on 1 September
A survey by National Price Council under the Ministry of Domestic Trade and Consumer Affairs revealed that the prices of 72% of consumer goods declined by up to 13% since the GST was lowered to 0%. The zero-rated GST will last until end-August, after which the government will implement a 10% sales tax and a 6% services tax effective 1 September 2018.

Monetary policy to stay accommodative amid benign inflation outlook
In our view, the inflation outlook is likely to remain subdued in 2H18 (+1.6% yoy in 1H18) even after taking into account the reintroduction of SST on 1 Sep 2018. Effective 1 July to 31 December 2018, TNB will implement a 1.35 sen per kWh surcharge on electricity tariffs, to account for higher fuel and generation costs under the Imbalance Cost Pass-Through (ICPT) mechanism. Nonetheless, households with monthly consumption above 300kWh will be spared from the ICPT surcharge as it will be funded by Kumpulan Wang Industri Elektrik. In the meantime, Telekom Malaysia has recently offered an entry plan for the B40 group (with monthly household income not exceeding RM4,500), as well as speed upgrades for existing broadband subscribers, which effectively translate to lower broadband prices per Mbps, pointing to the absence of inflation risk in the near-term. Hence, we maintain our 2018F headline inflation forecast at 1.3% yoy (+3.7% yoy in 2017). With inflation rate remaining below Bank Negara Malaysia (BNM)’s forecast of 2- 3%, we expect the central bank to leave Overnight Policy Rate (OPR) unchanged at 3.25% for the rest of 2018.

Originally published by CIMB Research and Economics on 18 July 2018.

HIGHLIGHTS

June 2018 trade

• Total trade growth eased in June on the back of fewer working days, while moderating import growth brought the trade balance back to a surplus of US$1.7bn.
• Export growth was supported by stronger volume growth, whereas price effect was the key driver of import expansion.
• With a quarterly trade deficit of US$1.3bn, we expect current account deficit to widen to US$6.7bn, or 2.6% of GDP in 2Q18.
• We project 2Q18 GDP growth to be a tad higher at 5.2% yoy, supported by positive contribution in net export volumes and stronger consumption.

Indonesia posted a trade surplus of US$1.7bn in June
Indonesia’s trade balance swung back to a surplus of US$1.7bn in June (CIMB forecast: +US$546m; Bloomberg consensus: +US$968m; May: -US$1.5bn) on the back of much subdued gross import growth at +12.7% yoy (CIMB forecast: +23.6% yoy; Bloomberg consensus: +29.1% yoy; May: +28.2% yoy). Gross exports grew +11.5% yoy during the month (CIMB: +10.6% yoy; Bloomberg consensus: +15.6% yoy; May: +13.1% yoy).

Weaker trade expansion due to a shorter working month…
In contrast to the Lebaran month in 2012-2017 which saw trade declining, total trade activity continued to expand in June 2018, on the back of resilient global trade activity and recovering domestic demand. The pace of expansion nonetheless eased (+12.0% yoy vs. +20.5% yoy in May) due to a shorter working month, as the government declared extra holidays surrounding the Lebaran festive season. There were 20% yoy fewer working days in June 2018 (12 vs. 15 in June 2017).

… but export volume growth quickened
Nonetheless, export volume growth accelerated despite fewer working days (+24.1% yoy in June vs +17.5% yoy in May). The acceleration may have been partly supported by a weaker currency, which improves export competitiveness, whereas higher O&G production in the country lifted O&G exports. On the flip side, the import growth was mainly led by price effects (+21.8% yoy in June vs. +17.0% yoy in May), compensating for the decline in import volume (-7.5% yoy vs. +9.7% yoy in May).

Imports of capital goods supported by delivery of train sets
By category, imports of consumption goods took a backseat at the end of 2Q18 after two months of robust growth (-9.5% yoy in June vs. +34.3% yoy in May), whereas imports of raw materials rose 14.6% yoy (+24.7% yoy in May). Imports of capital goods sustained their double-digit growth (+19.9% yoy vs. +43.1% yoy in May) due to the arrival of six train cars from South Korea for Jakarta LRT.

Trade deficit to translate into higher current account deficit
The large trade surplus in June was not sufficient to offset the deficit in Apr-May, resulting in a quarterly trade deficit of US$1.3bn in 2Q18 (+US$314m in 1Q18). Hence, we expect the current account deficit to widen to US$6.7bn, or 2.6% of GDP in 2Q18 (vs. deficit of US$5.5bn, or 2.1% of GDP in 1Q18). Meanwhile, net export volumes expanded 19.7% yoy in 2Q18 (+14.8% yoy in 1Q18), pointing to a potential positive contribution to GDP growth. Coupled with stronger retail and auto sales, we expect 2Q18 GDP growth to accelerate to 5.2% yoy. The 2Q18 GDP growth data will be released on 6 Aug 2018, and balance of payment on 10 Aug 2018.

Originally published by CIMB Research and Economics on 16 July 2018.

HIGHLIGHTS

2Q18 GDP growth (advance estimates)

• Singapore’s economy lost speed in 2Q18, expanding 3.8% yoy (+4.3% yoy in 1Q18) and 1.0% qoq SAAR (+1.5% qoq SAAR in 1Q18).
• While manufacturing remains a key engine of growth, we see headwinds gathering in 2H18 amid easing electronics demand and retaliatory tariffs by the US and China.
• Property cooling measures are a setback to our expectations of a quicker recovery in the construction sector, which extended its contraction streak to 8 straight quarters.
• Risks to the outlook are global trade tensions, tighter global financial conditions, slower growth in G3 and China as well as geopolitical uncertainty.
• We retain our forecast for MAS to maintain its current monetary policy stance, advocating a “gradual and modest” pace of appreciation for the S$NEER.

GDP growth slims down, marginally below expectations
Singapore’s economic expansion moderated to 3.8% yoy in 2Q18, based on the advance estimate from the Ministry of Trade and Industry (CIMB: +4.0% yoy, Bloomberg consensus: +4.1% yoy; +4.3% yoy in 1Q18). On a qoq seasonally adjusted annual rate (SAAR) basis, real GDP growth rose at a slower pace of 1.0% qoq, following a more robust reading of 1.5% qoq SAAR in the previous quarter.

and services sectors remain resilient
Production of electronics expanded by a slower 12.4% yoy in March (+17.9% yoy in February), on moderating growth for semiconductors (+18.8% yoy vs. +27.4% yoy in February), amid softening demand for smartphones. Output growth for computer peripherals remained stagnant (+0.2% yoy vs. +0.9% yoy in February) while contractions persisted in the data storage (-19.0% yoy vs. -21.8% yoy in February), consumer electronics (-7.7% yoy vs. -9.1% yoy in February) and other components (-0.5% yoy vs. -24.5% yoy in February).

Major revisions in pharma drags down headline IPI readings
Growth in the manufacturing sector remained healthy, albeit slower (+8.6% yoy vs. +9.7% yoy in 1Q18), on the back of strong performance in all segments within the sector, particularly led by electronics and biomedical manufacturing. Growth in the services sector eased to 3.4% yoy in 2Q18 (+4.0% in 1Q18), where momentum continued to be buttressed by wholesale and retail trade as well as the financial and insurance segments.

Property cooling measures to dampen construction turnaround
In contrast, the construction sector remained the underperformer as the sector contracted for the eighth consecutive quarter (-4.4% yoy vs. -5.2% yoy in 1Q18), weighed down by private sector construction activity due to the contraction in contracts awarded, which fell 67.5% yoy in May (+39.1% yoy in Apr). In a setback for the residential construction segment, the government recently announced property cooling measures, namely adjustments in the Additional Buyer’s Stamp Duty (ABSD) rates and Loan-to-Value (LTV) limits following a sharp rebound in land prices and en-bloc sales. Particularly for the developers, the additional 5% ABSD rate could raise the cost of land acquisition and reduce the bullishness of tender bids.

Growth outlook remains positive but downside risks gather
Singapore’s economy remains on track to meet our 3.2% GDP growth forecast for 2018, which is broadly in line with the Ministry of Trade and Industry’s (MTI) projection of 2.5% to 3.5%. We are wary of risks arising from disruptions to the trade cycle from incoming tariffs by the US and China, increased protectionist policies by major trade nations, higher interest rates and tighter financial conditions as a result of global monetary policy normalisation, geopolitical uncertainty, and a sudden loss of momentum in the advanced economies and China.

MAS to maintain monetary policy stance
Price pressures remain non-threatening as we forecast headline inflation to moderate to 0.6% in 2018F (+0.6% in 2017), aligned with MAS’s expected range of 0% to 1%. Headline inflation edged up to 0.4% yoy in May (+0.1% yoy in April) due to higher food prices as well as healthcare and education costs. As the balance of risks has tilted towards downside to growth, we expect MAS stay the course on its current guidance for a “gradual and modest appreciation” of the S$NEER at the upcoming Oct policy review. However, if global trade momentum slows sharply as the US and China step up trade threats, we expect MAS to stand ready to recalibrate policy settings to support the economy.

Originally published by CIMB Research and Economics on 13 July 2018.

HIGHLIGHTS

2019 Budget Consultation

• Fiscal reforms in Budget 2019 are aimed at promoting sustainable, equitable and inclusive growth while ensuring credibility, accountability and transparency.
• Cost cutting is not the government’s only focus, as economic expansion and wage gains for the B40 and M40 households are deemed equally crucial policy goals.
• The pro-consumer agenda and fiscal constraints mean businesses will have to play a key role in improving productivity and lowering costs in the economy.
• The government appears optimistic that the pain of reform adjustments can be shared without sacrificing economic growth (MOF: 5.0-5.5% in 2019 vs. CIMB: +5.0%)
• Delays in implementation and productivity gains may entail a trade-off between 1) economic growth, 2) near-term fiscal discipline or 3) a pared down reform agenda.

Fiscal reset to achieve sustainable and equitable growth
We attended the 2019 Budget Consultation today at Putrajaya, chaired by Finance Minister YB Lim Guan Eng (FM). Fiscal reforms in Budget 2019 are part of policies aimed at promoting sustainable, equitable and inclusive growth while ensuring credibility, accountability and transparency.

Key focus areas for reforms
The government’s top structural challenges were 1) incomprehensive social safety nets and rising costs of living, 2) stagnant productivity growth and low returns to labour, 3) insufficient high-skill, high income jobs for locals and a need for the labour force to adapt to technological disruptions and 4) non-inclusive and unbalanced economic development.

Government remains upbeat on economic prognosis
The FM believes robust economic growth provides the fiscal room for reforms. At this juncture, the FM expects Malaysia’s economic expansion to sustain at a pace of 5.5-6.0% in 2018 (CIMB: +5.2%) and 5.0-5.5% in 2019 (CIMB: +5.0%), though he acknowledged that the forecasts may be refined along the way up to the tabling of Budget 2019, tentatively slated for 2 November 2018. In particular, the government is monitoring external developments such as the global trade tensions, geopolitical uncertainty as well as volatile movements in the financial and commodity markets.

Room to manoeuvre limited by fiscal constraints
The FM intends to maintain fiscal discipline with the budget deficit to “remain low” without providing a target, and was keen to manage expectations on additional fiscal space for government expenditure. Public procurement processes would be improved to stem leakages and government tenders would be judged by financial viability. The government would consider projects that are not financially viable if they produce large positive externalities for the economy, but only under rigorous cost controls. The government expects to retain its credit rating and would engage with ratings agencies to explain the scope of its policies.

Boosting labour’s share of income alongside cost of living cuts
A recurring theme during the event was the need to raise Malaysia’s labour share of income, which stood at 35% of GNI (vs. ~40% in advanced economies). In the FM’s view, reforms are needed to improve income growth for the B40 and M40 groups as the trickledown economics approach of the previous regime has worked too slowly. However, he acknowledged that wage growth has to go hand-in-hand with higher productivity. Addressing market inefficiencies and distortions such as monopolies, price floors/ceilings or government subsidies were also means to reducing the cost of living.

Squaring the circle via productivity growth and private sector
With government finances pinched, the FM said the onus falls on greater efficiency and productivity from the corporate GLC and private sector to drive the economy. Participants from the floor raised concerns that businesses are bearing the burden of economic adjustments through higher costs of doing business and domestic policy uncertainty, particularly surrounding tax and foreign labour. Inevitably, reducing market distortions and improving the cost of living requires both lower deadweight losses and compressed producer surpluses.

Achieving ideal outcome rests on implementation
The Budget Consultation did not reveal further details on specific policies, which is understandable as many Cabinet ministers have only recently taken over their portfolios. Proposals are likely to crystallise as the budgetary process continues in the next three months. Our key takeaway is that the government appears optimistic that the pain of adjustments to reforms can be shared without sacrificing growth. If implementation timelines slip or reforms take longer to bear the fruits of productivity gains, then policymakers may have to be prepared to sacrifice 1) economic growth, 2) near-term fiscal discipline and the budget deficit target or 3) pare down its reform agenda.

Originally published by CIMB Research and Economics on 12 July 2018.