Indonesian bonds close higher on BI rate cut expectations

The Indonesian government bonds closed higher Monday as on rising expectations for further Bank Indonesia easing in the up-coming policy meeting. Also, investors shifted to safe-haven buying after Parliament approved a tax amnesty and revised 2016 state budget last week.

The yield on the benchmark 10-year bonds fell more than 13 basis points to 7.281 percent, yield on 20-year bonds dipped 11 basis points to 7.562 percent and the yield on short-term 1-year note tumbled 7 basis points to 6.822 percent.

It is not self-evident that Friday’s CPI release will allow the central bank to ease at the next monetary policy meeting later this month, as although CPI inflation remained subdued in June, it actually rose to 3.5 percent y/y, bit higher than the market consensus of 3.4 percent y/y, from 3.3 percent y/y in May.

Understandably, central banks can be averse to easing policy in the face of rising inflation because of the impact this might have on credibility and future signalling. But in recent weeks, BI has hinted at the possibility of another rate cut, if conditions permit.

Last week, BI senior deputy governor Adityaswara noted that that benign inflation, a stable FX rate and a manageable current account deficit would allow the central bank to ease further to boost growth. It is worth remembering that BI cut the key policy rate by 25 basis points to 6.50 percent in June. This was the fourth rate cut in 2016.

But more monetary accommodation might not be needed right now because the economy appears to be recovering thanks to a pick-up in the manufacturing sector as the latest Nikkei manufacturing PMI showed (also released on Friday). The index rose to 51.9 in June from 50.6 in May, the highest reading since July 2014, with the output sub-index rising to 52.5 in June from 50.0 in May. As we have been pointing out, the government is continuing with measures to boost growth and is taking steps to rebalance the economy away from its reliance on commodities.

Since September 2015 President Widodo’s administration has brought in a raft of supply-side measures to make it easier to invest in Indonesia and boost households’ purchasing power. Meanwhile, the breakup of CPI data showed, food inflation staying at 7.8 percent y/y in June. Housing costs were up 1.2 percent y/y in June after 1.3 percent y/y in May and transportation costs declined by 1.0 percent y/y in June after –1.5 percent y/y in May. Core CPI inflation edged up to 3.5 percent y/y in June (consensus was for 3.4 percent y/y) from 3.4 percent y/y in May.

On last Tuesday, The Indonesian government has approved a tax amnesty bill that is aimed at reducing the widening budget gap as it steps up infrastructure spending to spur economic growth. The government plans to draw billions of dollars needed to fund the cause.

Lawmakers voted in favor of the bill during a plenary session in Jakarta on Tuesday, among the final steps before it becomes law. Individuals who repatriate undeclared assets held abroad will face a penalty of 2 percent to 5 percent, according to the bill. However, a penalty of 4 to 10 percent will be levied on individuals who report assets held abroad but decline to repatriate the funds. Participants must keep the funds onshore for three years.

The central bank estimates the tax program which will be implemented in July and run for a maximum of nine months, to help draw 560 trillion rupiah (USD42.5 billion) of funds back to the country. Almost 30 percent, or 165 trillion rupiah, will flow to the government, Bloomberg reported, citing, Finance Minister Bambang Brodjonegoro.

"The first benefit from the tax amnesty would be the potential for capital inflows, which will really help the economy that’s currently seeking new sources of growth after a period of low commodity prices," the FM said in an interaction with reporters.

Meanwhile, The benchmark Jakarta Stock Exchange Composite (JKSE) was closed down 0.90 percent, or 45.066 points, at 4,971.581.