1

Survive with Stability amid the Global Dynamics Executive Summary

• GDP growth continued the recovery trend in 1H2018 (GDP growth was recorded at 5.06% and 5.27% YoY in 1Q and 2Q 2018) despite the high global uncertainty. The first quarter growth was driven by investment in relation to the government’s massive infrastructure project, while in the second quarter, GDP was led by household consumption, boosted by government’s incentive such as social spending. Going forward, 2H2018 economic growth would still be relying on household expenditure performance, since the investment will likely to moderate approaching the presidential election year.

• In the short to medium terms, although the majority of the domestic macroeconomic indicators are still in healthy condition, we see the potential of Rupiah volatility to remain high considering the potential of widening current account deficit (CAD) due to impact of global sentiment especially from the US. Specifically, the risk of foreign capital outflows may be one of the main factors that will affect the Rupiah movement. We project the Rupiah at the end of the year to be in a range of 14,900-15,400 per USD.

• We decide to revise down our GDP growth forecast for 2019 considering the volatility of the global economy that may disturb Indonesia economic growth such as trade protections and normalization trend. These dynamics have been responded by policy makers through tighter fiscal and monetary stance in order to maintain macro stability (BI with its “pre-emptive, front loading, and ahead of the curve” have hiked BI 7DRRR by 125 bps YTD 2018; while from the fiscal side the government will maintain low budget deficit, targeted at below 2% of GDP in 2019 budget, followed by its decision to limit import).

September 2018 Edition TALITHA NADIA AUDITA RESEARCH ANALYST

RESEARCH UNIT INVESTMENT BANKING DEVELOPMENT DEPARTMENT

+6221 5706185 EXT 2957 talitha_nadia_audita@id.mufg.jp

Indonesia Monthly Economic Update

MUFG Bank, Ltd. Jakarta Branch A member of MUFG, a global financial group 412/IBDD-RU/2018/TN

Indicators (Quarterly)* 4Q2016 1Q2017 2Q2017 3Q2017 4Q2017 1Q2018 2Q2018 GDP Growth 4.94% 5.01% 5.01% 5.06% 5.19% 5.06% 5.27% Current Account / GDP (%) -0.75% -0.90% -1.86% -1.76% -2.26% -2.21% -3.04%

Indicators (Monthly)* Feb-18 Mar-18 Apr-18 May-18 J un-18 Jul-18 Aug-18

Trade Balance (USD mn) -53 1,123 -1,625 -1,454 1,707 -2,007* -1,021 Foreign Exchange Reserve (USD bn) 128 126 125 123 120 118 118 USD/IDR Exchange Rate (IDR per USD) 13,707 13,756 13,877 13,951 14,404 14,413 14,711

Inflation (YoY) 3.18% 3.40% 3.41% 3.23% 3.12% 3.18% 3.20% BI 7 Day RR Rate 4.25% 4.25% 4.25% 4.75% 5.25% 5.25% 5.50% Source: Statistics Indonesia, Bank Indonesia, CEIC, IBDD Research Unit Note: *) The figures above are subject to change in line with any revisions by Statistics Indonesia

Table 1: Indonesia Macroeconomic Indicators*

2

TRADE BALANCE Trade deficit narrowed as coal export was influence d by seasonality factor • The trend of Indonesia trade deficit

continued for two consecutive months as August 2018 reported another monthly deficit of USD 1,021 mn (Figure 1). However, the deficit has shrunk as compared to the previous month as import fell deeper than export.

• August’s import has softened from July 2018 level, in which import soared to above 60% MoM due to normalized domestic production post Eid-Al Fitri. The August’s import decline of 8% was mainly impacted by raw material and capital goods. These items include the likes of machinery, iron and steel as well as vehicle and parts. Despite only just occurred for a short while, the slower import level may indicate deceleration of infrastructure and production activities.

• Meanwhile, August’s export also reported a decline although by only 3% MoM. The lower export was mainly impacted by notable decline of mineral fuel (coal) export of about USD 381 mn (most likely seasonality factor i.e. end of summer in Indonesia’s coal export destinations) as well as softening gas export.

• We observe that there is chance that the trend of narrowing deficit to continue approaching end of the year. Imports for infrastructure could moderate along with government’s plan to evaluate import-dependent construction projects and improve utilization of local products in a bid to ease pressures on IDR exchange rate.

• Furthermore, many local manufacturers see that the current IDR depreciation could improve price competitiveness of domestic output and reveal opportunity for higher export growth in the coming term. They also propose the government to issue export-incentive package (that include subsidy for export credit interest rate and various tax reliefs) to accelerate export growth, while

proactively work on various trade agreements to uncover potential market in non-traditional export destinations.

Source: Statistics Indonesia, obtained from CEIC Note: *) The figures above are subject to change in line with any revisions by Statistics Indonesia

Figure 1: Indonesia Trade Balance

Source: Statistics Indonesia, obtained from CEIC Note: *) The figures above are subject to change in line with any revisions by Statistics Indonesia

Table 2: Indonesia Trade Balance*

in USD mn* Jul-18 Aug-18 MoM Change YoY Change USD mn % USD

mn %

Total Exports 16,290 15,818 -472 -3% 589 4% Non-O&G Exports 14,859 14,434 -425 -3% 481 3%

O&G Exports 1,431 1,385 -47 -3% 108 8%

Total Imports 18,297 16,840 -1,458 -8% 3,330 25% Non-O&G Imports 15,637 13,794 -1,843 -12% 2,296 20%

O&G Imports 2,660 3,046 386 14% 1,034 51%

Trade Balance -2,007 -1,021 985 49% -2,741 -159% Non-O&G Balance -778 640 1,418 -182% -1,815 -74%

O&G Balance -1,229 -1,661 -432 -35% -927 -126%

3

FOREIGN EXCHANGE RESERVES

Forex reserves fell slightly in Aug • Rupiah weakening has made BI to take

several policies to maintain the stability of Rupiah, one of them is the use of forex reserves. At the end of Aug 2018, BI had the reserves position at USD 117.9 bn, declined slightly from Jul 2018’s position of USD 118.3 bn (Figure 2).

• Aug’s position decreased by USD 13.7 bn from the end of Jan 2018 (YTD) which amounted to USD 131.9 bn. In addition to stabilization of Rupiah, the lower forex reserves were also influenced by the forex usage for government’s external debt repayment. However, the current forex reserves position of above USD 100 bn was considered to still be able to support Indonesia’s resilience from external conditions and maintain macroeconomic and financial system stability.

• The Aug’s reserves were sufficient to cover 6.8 months of imports as well as 6.6 months of imports and the government’s external debt repayments, which were above the

minimum international adequacy standards of three months of imports. (Table 3).

EXCHANGE RATE

The Rupiah weakened consistently since the beginnin g of 2018

• In Sep 2018 the Rupiah fluctuated between 14,767-14,938 per USD, weakened consistently since the beginning of 2018 (Figure 3). Depreciation of the Rupiah against the USD was mainly caused by US normalization and Indonesia’s rising CAD.

• The strengthening USD was caused by increasingly interested foreign investors in entering the US market, in line with improvements in the labor sector, rising inflation, and investor’s optimism about the US economic outlook. In addition, after increasing their rates on 26 Sep (the third time this year) to a range of 2-2.25%, the Fed plans to keep gradually raising interest rates. We expect the Fed to raise its benchmark

interest rate once more in Dec 2018, which may put further pressure on Rupiah.

Figure 2: Indonesia Foreign Exchange Reserves

Source: Bank Indonesia, obtained from CEIC

Figure 3: USD/IDR Exchange Rate

Source: Bank Indonesia, obtained from CEIC

(in months) May-18 Jun -18 Jul -18 Aug -18 Forex Reserves to Import 7.4 7.2 6.9 6.8

Forex Reserves to import and govt. external debt repayments

7.2 6.9 6.7 6.6

Table 3: Indonesia Forex to Import and Debt Repayment

Source: Bank Indonesia

4

BI RATE

• BI on Sep 27th 2018 raised its benchmark interest rates for the fifth time this year. BI 7-DRRR went up by 25 bps to 5.75%, while the deposit and lending facility rates have also been raised by 25 bps to 5% and 6.50%, respectively (Figure 4).

• The Fed normalization policy as well as the country’s widening CAD that has resulted in the weakening Rupiah has triggered BI to raise its stance. However, we think Sep’s policy rates hike was the last in this year as the previous 150 bps hikes was considered sufficient to maintain an attractive interest rate differential between the US and Indonesia in the medium term.

• For next year, we believe the central bank may continue to increase interest rate on the back of higher inflation forecast, as a consequence of retail fuel price increase and maintain the real interest rate differential between Indonesia and the US. Thus, we estimate BI needs to increase policy rates by approximately three times next year, assuming the FFR to increase up to 3% in 2019.

Figure 4: BI Benchmark Rates

Source: Bank Indonesia, obtained from CEIC

BI has increased the policy rate by 150 bps YTD to 5.75% to aid Rupiah

5

INFLATION

Inflation maintained at low for now; but potential administered price hike next year • Indonesia recorded deflation of 0.05% MoM

in Aug 2018, in contrast with July’s inflation of 0.28% MoM (Table 1). As per Statistics Indonesia, Aug 2018’s deflation was mostly caused by seasonal factors, i.e. harvest season of spices, fisheries and several vegetables, which were reflected in deflation of volatile food component. This lower MoM price index also reflected the lower air transportation services fares due to lower demand. However, on yearly basis, August inflation increased slightly to 3.20% YoY, mainly attributed by higher foodstuff price

relative to the same period last year, during which Indonesia also experienced greater deflation (0.07%).

• Broken down by component groups, yearly inflation in Aug 2018 was mostly attributed by volatile food with inflation rate of 4.97% YoY (Figure 2). Furthermore, core and administered price components recorded increase of 2.9% and 2.55% YoY respectively. We see that imported inflation has not given significant impact on the core component. Nevertheless, if the Rupiah keep on weakening in the medium to long term, we shall anticipate the impact on inflation.

• According to Statistics Indonesia’s survey in 82 cities, 52 cities experienced deflation and

the rest recorded inflation. Bau-Bau (Southeast Sulawesi) recorded the highest deflation of 2.49% MoM, on the other hand, Tarakan (North Kalimantan) recorded the highest inflation of 0.62% MoM.

• In the short term, we believe inflation will remain under-controlled. The food stock from harvest season is predicted to be sufficient to cover demand up to Sep 2018. Furthermore, the government has assured to maintain food stock adequacy as well as energy price during the year. With four months remaining toward the end of the year, the inflation target of 3.5% ± 1 will likely to be achieved, considering YTD inflation is still recorded at 2.13%.

Figure 6: YoY Inflation

Source: Statistics Indonesia, obtained from CEIC

Period YoY* MoM** Aug-17 3.82% -0.07% Sep-17 3.72% 0.13% Oct-17 3.58% 0.01% Nov-17 3.30% 0.20% Dec-17 3.61% 0.71% Jan-18 3.25% 0.62% Feb-18 3.18% 0.17% Mar-18 3.40% 0.20% Apr-18 3.41% 0.10% May-18 3.23% 0.21% Jun-18 3.12% 0.59% Jul-18 3.18% 0.28%

Aug-18 3.20% -0.05%

Table 4: Indonesia Inflation

Source: Statistics Indonesia, obtained from CEIC

Figure 5 : Contribution to Aug Inflation by Expenditure Group

Source: Statistics Indonesia, obtained from CEIC

-0.05% Inflation in Aug

6

OUTLOOK

• Indonesia growth momentum will be mainly relying on the household expenditure performance in 2H2018. Investment growth is expected to moderate approaching to presidential election year, while the government start conducting efforts to control the widening CAD with import restriction that may potentially impact on production or some sectors performance.

• BI has just published Regulation of Bank Indonesia No. 20/10/PBI/2018 about “Domestic Non-Deliverable Forward (DNDF) transaction”, effective from 27 September 2018. The background of this policy issuance is to strengthen IDR exchange rate by increasing domestic foreign exchange market liquidity and efficiency with a hedging instrument.

• The vast recovery of the US economy might cause Rupiah to weaken further particularly in 2019. The faster-than-expected US economic growth followed by emerging inflationary pressure would make the Fed to add more tightening plan than previously arranged. For instance, the FFR hike expectation from two times early this year to four times by end of 2018.

• The above factor, combined with rising oil price and external uncertainties, e.g. trade war, the Argentina and Turkey’s crisis, has triggered a capital flight from emerging to developed countries. Moreover, the capital outflow occurred during Indonesia’s widening CAD due to import activities specifically for infrastructure. As the financial account surplus was not enough to finance the CAD, it has led Rupiah to weaken further. Going forward, we anticipate widening CAD since the import restriction policy probably needs time to be fully implemented, and the export expansion is not an instant process.

• The other challenges in the future that could affect Indonesia’s macro, among others: China’s deceleration growth that might limit the global commodity prices uptrend and at the end, affect to export performance of emerging countries including Indonesia. As such, we decide to revise down our GDP growth forecast for FY 2019 as the global economic uncertainties may remain high. These dynamics have been responded by policy makers through tighter fiscal and monetary stance in order to maintain macro stability (BI with its “pre-emptive, front loading, and ahead of the curve” have hiked

2H2018 macro performance may depend mostly on wheth er household consumption could continue the recovery momentum

Table 5: Historical and Forecasted Economic Indicat ors Indicators 2015 2016 2017 2018F* 2019F*

GDP Growth (% YoY) 4.88 5.02 5.07 5.16 5.20 Inflation (% YoY) 3.35 3.02 3.61 3.50 4.10 BI Rate (until 2015) / 7-Day RR Rate (%) 7.50 4.75 4.25 5.75-6.00 5.75-6.50 Current Account / GDP (%) -2.04 -1.82 -1.73 -2.50 -2.50 Exchange Rate (USD/IDR) 13,795 13,436 13,548 See Table 6 See Table 6

Source : Statistics Indonesia (obtained from CEIC), IBDD Research Unit’s Calculation Note : 2015 – 2017 figures are historical figures; 2018 – 2019 figures are forecast

Table 6: Exchange Rate Forecast*)

Indicator 2018 2019

Q1 Q2 Q3 Q4 (F)* Q1 (F)* Q2 (F)* Q3 (F)*

Exchange Rate (USD/IDR)

13,290-13,794 13,747-14,404 14,326–14,938 14,900–15,400 14,900–15,400 15,000-15,500 15,100-15,600

Source: MUFG Jakarta Branch’s forecast *) Note: We may revise our forecast depending on market and economic condition

7

BI 7DRRR by 150 bps YTD 2018; while from the fiscal side, the government will maintain low budget deficit, targeted at below 2% of GDP in 2019 budget, followed by its decision to limit import).

• We also revise up next year’s inflation forecast to approximately 4.1% from initially 3.8% assuming a fuel price increase in 2019 and higher imported inflation due to Rupiah depreciation.

(End of Report)

8

APPENDICES:

Appendix 1: 4W Monthly Sales

Source: GAIKINDO, Astra International

Appendix 2: 2W Monthly Sales

Source: AISI, Astra International

9

Appendix 3: Retail Sales Index

Source: Bank Indonesia

Appendix 4: Consumer Confidence Index

Source: Bank Indonesia, extracted from CEIC

10

Appendix 5: Manufacturing Purchasing Manager’s Inde x

Source: Nikkei, obtained from Bloomberg

Appendix 6: Indonesia Crude Oil Price

Source: CEIC

11

Appendix 7: Indonesia Coal Price Reference

Source: Ministry of Energy and Mineral Resources, obtained from CEIC

Appendix 8: Malaysia Palm Oil Board – Crude Palm Oi l Monthly Average Price

Source: Malaysia Palm Oil Board

12

Figure 12: Commodity Price Forecast

Appendix 9: Commodity Price Forecast

Source: World Bank Forecast

Appendix 10: NPL and Credit Growth in Commercial Ba nks

Source: OJK (Indonesia Financial Services Authority), obtained from CEIC

13

APBN 2018

(Approved) YTD Aug 2018 Realization

YTD Aug 2018

Realization vs

FY Target

Δ Realization YTD

Aug 2018 vs YTD Aug

2017

Government Revenue & Grant 1,894.7 1,152.8 60.8% 18%

Domestic 1,893.5 1,147.8 60.6% 18%

Tax 1,618.1 907.5 56.1% 17%

Non-Tax 275.4 87.2 31.7% -55%

Government Grant 1.2 5.0 415.8% 316%

Government Expenditure 2,220.7 1,303.5 58.7% 9%

Central Government 1,454.5 802.2 55.2% 15%

Regional Transfer and Village Funds 766.2 501.3 65.4% -0.3%

Regional Transfer 706.2 465.1 65.9% -0.2%

Village Fund 60.0 36.3 60.4% -1%

Adjustment (Primary Balance) -87.3 11.6 -13.3% -114%

Government Deficit or Surplus -325.9 -150.7 46.2% -33%

% Deficit or Surplus to GDP -2.2 -1.0 n.a. n.a.

Government Financing 325.9 265.6 81.5% -20%

Debt Financing 399.2 274.3 68.7% -17%

Investment Financing -65.7 -10.4 15.9% 3380%

Loan Provision -6.7 1.6 -24.4% -29%

Other Financing 0.2 0.1 61.1% -63%

Appendix 11: Indonesia State Budget Realization up t o Aug 2018 (IDR tn)

Source: Ministry of Finance

14

MUFG Bank, Ltd. Jakarta Branch ECONOMIC RESEARCH TEAM

Budi Mulyono Rahmat Hendratama Head of Market Sales & Trading Dept Head of Investment Banking Development Dept budi_mulyono@id.mufg.jp rahmat_hendratama@id.mufg.jp

Ronald Charles Talitha Nadia Audita Senior Research Analyst – IBDD Research Analyst - IBDD ronald_charles@id.mufg.jp talitha_nadia_audita@id.mufg.jp Ersaly Aisyah Erwinputri Research Analyst - IBDD ersaly_aisyah_erwinputri@id.mufg.jp

Disclaimer This report was prepared by MUFG BANK, LTD., Jakarta Branch (the “Bank”) for general distribution. The report does not represent the Bank’s view nor does it imply the Bank’s endorsement. This report is delivered to you on the basis of your agreement to preserve the confidentiality of the information contained herein and of the nature of the report, except to the extent that such information was already known to you or was public knowledge or in public literature generally available to the public or otherwise in the public domain, at the time of such disclosure to you, or otherwise become lawfully known to you without breach of any duty of confidentiality by any person. The Bank has endeavored to include in our report only such information as it believes to be correct, however we do not make any representation or warranty as to the accuracy or completeness of such information. Moreover, any past performance of related items shown in the report does not guarantee future performance of projection. The Bank does not pledge to the finalization and execution of the proposals illustrated herein. The information and data contained therein are not a substitute for the recipients’ independent evaluation and analysis. This report is not, nor should it be construed as, any financial commitment, either expressed or implied, by the Bank to lend or provide the Bank’s products and/or services to any other parties in any way whatsoever. This report is protected by copyright laws under applicable jurisdictions. Information contained herein may not be reproduced, distributed, transmitted, displayed or broadcasted without prior written consent of the Bank.