04/08/2011 (Jakarta Post) - Indonesia’s inflation rate in July surprised us and the market, coming in as it did at 0.67 percent month-on-month (m-m), which was below our estimate of 1.04% m-m and consensus forecast of 0.85 percent m-m. While July’s consumer price index (CPI) is at a six-month high, it fell from June’s level of 5.54 percent year-on-year (y-y) to 4.61 percent y-y (14-month low), partly due to a higher base.

Higher staple food prices and education costs (exhibit 1), were the main drivers for July’s inflation, leading up to August’s fasting month and back-to-school effect. Note that, compared to June’s level of 4.63 percent y-y, July’s core inflation eased to 4.55 percent y-y, bringing a year-to-date figure of 1.73 percent.

Separately, Indonesia reported in June total exports of US$ 18.4 billion, up 49.3 percent y-y. This brought a growth in exports to 36 percent y-y for the first half of this year, or US$ 98.6 billion, propelled by crude palm oil (CPO), rubber and mineral fuel sales.

On the flip side, June imports fell 28.3 percent y-y to US$ 15 billion, but up 32.8 percent y-y in the first half of 2011, to US$83.6 billion, bringing trade surplus to US$13.4 billion in the first half of the year.

On the back of July’s relatively subdued annual headline and core inflation rates, the central bank (BI) is unlikely to change its current monetary policy, keeping their rate at 6.75 percent at the next board of directors’ meeting on August 12. In fact, we expect the BI rate to remain unchanged throughout the year.

It is worth pointing out that, although the government found indications of rice hoarding at the beginning of Ramadhan, which triggered rice prices to soar, the State Logistics Agency’s (Bulog) stockpile was sufficient to meet consumption for the next seven months, following a 500,000 tons rice import from Vietnam this month.

This will limit any increase in the price of rice during the fasting month, and we expect less growth of the CPI in August, compared to the same period last year.

Additionally, it is worth highlighting that the parliament and the government had agreed to raise fuel subsidy to Rp 129.7 trillion in the 2011 revised state budget, up 35.2% from Rp 95.9 trillion previously.

This suggests that the current subsidy policy will remain till year end, paving the way for lower inflation. As a result, we have cut our 2011 inflation rate target to 4.93% y-y from 7.04% y-y previously, much lower than the government’s current target of 5.3%, particularly given our expectation of moderate food price increases during the fasting month and post-Lebaran periods.

Additionally, we also expect low inflation to benefit from rupiah stability and manageable global commodity price increases going forward. In 2012, assuming the government will continue to maintain its current subsidy policy, we expect continued low inflation rate of just 5.66% y-y next year.