New Market Research Report: Indonesia Country Risk Report Q3 2016

We expect Indonesia's real GDP growth to pick up pace in 2016, underpinned by strong investment and government spending. The government's accommodative monetary and fiscal stance should help to mitigate external headwinds, informing our forecast for Indonesia's real GDP to expand by 5.2% in 2016.

Indonesia's fiscal balance will likely deteriorate in 2016 as a combination of lower-than-expected revenue realisation and strong capital expenditure result in a wider shortfall. As such, we forecast Indonesia's budget deficit as a share of GDP to widen to 2.7% in 2016, versus our previous forecast of 2.5%. The weakening of the government finances could lead to expenditure cuts, potentially undermining the growth outlook for the Indonesian economy in 2016.

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Major Forecast Changes

Given our expectations for continued emerging market FX outperformance over the coming quarters, we have shifted to a more neutral view on the rupiah, and now expect the unit to fall from the spot rate of IDR13,060/USD, to IDR13,600/USD by end-2016, versus our previous forecast of IDR14,600/USD. Although our end-year forecast for the rupiah marks a depreciation of about 4.3% in nominal terms from the current exchange rate, in total return terms, the currency is likely to outperform the US dollar.

Recent improvements in Indonesia's political environment have prompted an upward revision of its short-term political risk score (from 68.8, to 72.9), reflecting positive momentum. However, we stress that political patronage and corruption will remain a hurdle to the legislative process. Moreover, the decentralised form of governance in the archipelago will likely result in slow policy implementation outside of Jakarta, thus limiting the effectiveness of Jokowi's pro-investor policies.

After three consecutive interest rate cuts in three months, Bank Indonesia will likely stand pat on its interest rate policy over the near-term as it monitors the effects of its stimulus measures. However, given that the risk of fiscal tightening is rising, we expect the central bank to adopt a more accommodative monetary policy stance and ease its reference rate by an additional 25 bps in H216 to continue to support growth.

Key Risks

Indonesia risks a return to the more polarised political environment witnessed before outgoing President Susilo Bambang Yudhoyono took office in the mid-2000s.

Indonesia's poor net international investment position, along with a current account deficit, makes it vulnerable to periods of acute risk aversion in the global economy. In an environment of rising global interest rates, this is an increasing risk.

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