Indonesia on right track as oil prices fall

Indonesia is set for a great turnaround in 2015. Falling commodity prices and the government’s decision to take advantage of lower oil prices by significantly reducing the domestic fuel subsidy program will mark a turning point for the country’s fiscal and current account balances. These changes will have a material impact on sovereign bond performance.

Furthermore, falling inflation will also help to reset the local bond yield curve. Fiscal Turnaround With global oil prices at current depressed levels and with the government ending its gasoline subsidy and sharply reducing diesel fuel subsidy domestically, Indonesia is expected to save some US$18 billion— or 2.3% of gross domestic product Lower oil prices are helping Indonesia cut its fiscal shortfall, reducing the need for government bond issuance, and narrow its trade deficit. Moreover, they are helping to contain inflation. All of these effects are contributing to brightening the outlook for the local bond market. (GDP)—in its annual budget.

This means that a projected fiscal shortfall of 2.4% of GDP in 2015 will effectively be erased. If none of the savings are spent on new initiatives, such as those in infrastructure and social welfare, the government’s funding needs—thus bond supply—will be greatly reduced, supporting local-currency bond performance. Even if 60% of the windfall is to be spent, as long as that goes to productive projects—as officially promised—a resultant boost to future productivity and growth would bring about structural improvements.

At any rate, what matters the most is that Indonesia’s fiscal shortfall will not blow up, as some had worried previously, and should be contained at less than 1% of GDP this year. This makes Indonesia stand out among the “fragile” emerging economies. Worst of Trade Deficit Is Over The worst of Indonesia’s trade deficit is behind us, thanks to the positive terms-of- trade effect and the still-depressed domestic demand. Outside oil and gas, Indonesia is running a persistent monthly trade surplus of some US$1 billion, while the oil and gas deficit has already shrunk to US$1 billion in December 2014 from US$1.4 billion in November owing to the oil price decline. We believe that the full impact of falling oil prices has yet to be seen and that the oil trade deficit will easily be halved as prices stay low.

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