Bahana Securities - Higher fuel prices: Transitory shock

by ArgaSamudro

Economist Bahana Securities

Post a two-year long-drawn-out political squabbling, the government finally raised subsidized fuel prices last week. Along the lines of a previous plan, regular (called “Premium”) gasoline price was adjusted to IDR6,500/ltr (+44%), while diesel price increased to IDR5,500/ltr (+22%), providing average 33% fuel price hike, the first since April 2008 (exhibit 1).

The government has set aside around IDR28t compensation programs to cushion the impact of higher fuel prices, through several programs:
·         IDR12.6t in social assistance, in the form of scholarships for poor students (IDR7.5t) and food subsidies (IDR5t);
·         Direct cash aid (BSLM) totaling IDR9.3t, to be disbursed to 15.5m targeted households. Each household will receive IDR600k over four months;
·         IDR6t spending in undeveloped rural areas through infrastructure projects: water irrigation (IDR2t), housing (IDR2t) and drinking water (IDR2t).

Going forward, we reiterate our estimate of 2013 CPI of 8.85% y-y on higher fuel prices coupled with demand-pull inflation ahead of the fasting month and Lebaran. Without factoring in weather disruptions, we expect inflation to normalize, settling at our structural CPI of 5%-6% starting in mid-2014, reaching 5.63% by end-2014 (exhibit 2).

To manage rising inflation ahead, we expect BI to raise rates by a further 75bps to 6.75% in 2013, before lowering to 6.25% in 2014 on normalizing CPI (exhibit 2).

As higher fuel prices tend to lower Indonesia’s fuel consumption and reduce oil imports, we expect improved 2013 balance of payments deficit, paving the way for higher sovereign rating ahead.  This could gradually stabilize the IDR, from a current 10,065/USD (exhibit 3) to 9,700/USD in 4Q13, strengthening slightly to 9,650/USD by end-2014, despite political election risk.

Following our 2013F GDP growth of 5.9%, transitory impact of higher fuel prices will see higher 2014 GDP growth of 6%, helped by solid investments (exhibit 4).

Exhibit 1. Historical trends of fuel prices, inflation and BI rates
Source: Statistics Indonesia, Bank Indonesia and Bahana estimates

Exhibit 2.Inflation & BI rates 2013F-2014F
Source: Statistics Indonesia, Bank Indonesia and Bahana estimates

Exhibit 3.IDR movements, Jul 04-Jun 13
Source: Bloomberg

Exhibit 4.Real GDP growth, 2008-2014F
Source: Statistics Indonesiaand Bahana estimates