Indonesia Strategy, Fuel Price Hike? Positive for Equity, Negative for Bond Markets, Citi

 The government may increase the subsidized fuel price; Every Rp1,000/litre will
save Rp38trn ($4.5bn) in government’s budget — The Energy and Mineral Minister
said that the government is considering raising the price of subsidized fuel (for
everyone including 2W and public transportation) by up to Rp1,500/litre from Rp4,500
to Rp6,000/litre. The earlier plan to prohibit subsidized fuel consumption by private car
users appears to have been sidelined, but the decision to increase fuel prices will
require parliamentary approval (while the approval for rationing was already at hand).

 Impact to inflation and purchasing power? — We believe that the decision to
increase fuel prices will have broader base impact on inflation vs. the quantity limitation
but there will be less leakage and the government could spend more money on
infrastructure (i.e. after any cash subsidies to the poor). By our calculation, the
incremental impact of a 33% increase could reach almost 3.5 percentage points (pps)
against a no-hike and no rationing scenario (currently core inflation is around 4.3pps).
Purchasing power may be impacted, however formal sector workers are somewhat
buffered by the higher average minimum wage increase of over 12% this year.
 Experience from the past? Positive — Equity market usually reacts more positively
on fuel price hikes, such as in February 2005 and May 2008. We exclude October 2005
given the size of the fuel price hike. When the fuel prices were hiked by around 30%,
the equity market reacted positively amid expectations that the government could use
the cash savings for more efficient infrastructure-related spending.
 Yield curve may see steepening, but impact could be cushioned; Low interest
rate environment remain intact— As any fuel price hike will be a one-off event, we do
not think it will lead to an increase in BI policy rates (although BI may revisit its dovish
inflation view and pause the rate cuts). However, higher-than-expected inflation may
lead to a rise in long-term yields, although the extent will probably be cushioned if BI
maintains its presence in the market.
 Real underlying demand remains strong; no impact on 2W and 4W based on
historical data — We continue to believe that real underlying demand for Indonesia
remains robust. Our analysis on the 4W and 2W volume indicates that volume saw no
substantial impact when the fuel prices were hiked by 30% (Figures 4&5). Automotive
volumes tend to be impacted more by higher interest rates than by fuel price hikes.
 Maintain our positive view – The possible decision to increase the subsidized price is
positive longer term in our view, as subsidy reform corrects the misallocation in
spending (last year subsidy spending was higher than capital spending). There could
be some impact on inflation but, with rates still relatively low, we are maintaining our
positive view on the market with an index target of 4,450. We continue to like Bank
BNI, Bank Rakyat, Adaro, United Tractors, Indomobil, Harum Energy and Jasamarga.

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