An aerial view of Jakarta-Cikampek toll road on Dec 31, 2021. (Antara Photo/M. Ibnu Chazar)

Indonesia, Asean Peers Are Better Placed Against Stagflation: Morgan Stanley


MAY 17, 2022

Jakarta. Indonesia and some of its Southeast Asian peers are better positioned to stave off high inflation and slowing growth, or stagflation, thanks to windfall profit from high commodity prices and huge domestic demand, global investment bank Morgan Stanley said in a recent research report. 

The investment bank said the world's steady economic recovery today was under threat. Demand and supply-side shocks stemming from the war between Russia and Ukraine and China’s Covid-zero approach increase inflation risks and threaten to slow down growth. 


In addition, the Federal Reserve had taken a hawkish stance by increasing the interest rate and initiating quantitative tightening, shifting the global expansion gear down by a notch. 

That raises the question of whether economies in Southeast Asia could maintain their steady recovery. For Morgan Stanley, some of them could. 

"Economies with a stagflation hedge and domestic demand buffer are better positioned: Asean looks better placed vs. North Asia. In Asean, Indonesia,
Malaysia and the Philippines are better placed," Morgan Stanley wrote in the report. 

In terms of growth, rising commodity prices would lend a tailwind to commodity exporters like Indonesia and Malaysia at the expense of major importers like South Korea, Taiwan, and Singapore.

"For net commodity exporters ... the positive terms of trade provide additional liquidity to fund domestic demand (whether through fiscal resources or credit growth). This is particularly so for economies like Indonesia, which tend to be liquidity-constrained," Morgan Stanley said. 

The investment bank estimated every 10 percent rise in commodity prices across the board added to Indonesia's current account balance by 0.5 percent of gross domestic product (GDP). A similar increase in commodity price would reduce South Korea's current account balance by 0.9 percent of GDP.

The Covid-19 restrictions easing in the region also boost domestic demand. 

"The catch-up in domestic demand and services as social distancing and border restrictions ease is why growth should sustain a respectable pace," Morgan Stanley said. 

Indonesia has seen its Covid-19 new daily cases drop below 500 in the past two weeks after the Idul Fitri holiday. The government has also dropped quarantine requirements for foreign tourists and lifted Covid-19 test requirements for fully-vaccinated domestic travelers. 

Source: Morgan Stanley Research

How high could inflation go?

In terms of inflation, Morgan Stanley expected Indonesia's consumer price index increase would peak at 5.1 percent in the first quarter of 2023, from 2.3 percent in the first quarter this year. 

Still, revenue from commodity prices, coupled with enough fiscal room for subsidies and successful structural reforms in the past few years, should shield the largest economy in Southeast Asia from the inflation fallout. 

"The relatively manageable ratios of public debt to GDP mean that policymakers can and are using the public sector balance sheet to help vent some of the inflation/growth pressure," Morgan Stanley said. "As it stands, policymakers have retail fuel subsidies in place in Indonesia and Malaysia."

"For economies that historically have grappled with high inflation like Indonesia, structural reforms have been undertaken, which have led to lower lows and lower
highs in inflation.

"For example, de-dollarisation has helped to lessen the import-led pass-through from currency depreciation. Measures have also been undertaken to reduce the food demand-supply mismatch to mitigate food inflation," Morgan Stanley said. 

How tight could monetary policy get?

The investment bank expects an interest rate increase from Bank Indonesia around June this year to combat inflation that increases above the central bank's target of 2 to 4 percent. But, that would be a "policy normalization, not disruptive tightening," Morgan Stanley said. 

"Indeed, with CPI expected to go somewhat higher than BI's inflation target range of 2 percent to 4 percent in 3Q22, we expect BI to respond by raising rates 25bps each in the June 2022 and July 2022 meetings," Morgan Stanley said. 

"We then see BI raising rates 75 bps again in 1Q23 because we expect there could be adjustment in retail fuel prices (we penciled in a 25 percent increase) given the fiscal consolidation plans. If so, BI would likely want to respond to some of the second-round price pressures which could come through," the investment bank said.