Indonesia’s headline inflation accelerated to 3.19% YoY in August from 2.88% in July, while Bank Indonesia maintained the BI Rate at 5.75%. The increase was driven by renewed food-price pressure, with rice prices emerging as a key risk. Looking ahead, inflation could remain elevated toward year-end as El Niño threatens agricultural output, tighter fertilizer supply raises production costs, and the continued rollout of the MBG program adds to demand for premium rice.
Despite Bulog reportedly holding ample rice reserves, as of August, these still couldn’t effectively contain the rise in rice prices. (https://investortrust.id/business/111735/bos-bulog-tegaskan-mbg-gunakan-beras-premium-bukan-beras-subsidi)
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With the BI Rate at 5.75% against headline inflation of 3.19%, Indonesia’s real-rate spread currently stands at around 256bps. Even if BI delivers one final 25bps hike, the spread would remain comfortably positive. However, continued food-driven inflation would gradually compress the real-rate cushion, bringing the policy rate closer to the prevailing inflation environment.
Importantly, historically, periods of narrowing policy-rate-to-inflation spreads have coincided with stronger equity-market performance.
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BI cannot keep raising interest rates indefinitely to contain inflation, as at some point, economic growth could be severely affected. Therefore, at some point, BI may have to allow inflation to remain at a certain level, particularly as some inflationary pressures stem from factors beyond BI’s control, such as weather conditions and global geopolitical conflicts. As a result, the spread between the policy rate and inflation would likely continue to narrow. If the gap continues to narrow, local institutions and domestic investors could also begin shifting toward riskier assets. This also does not yet factor in the potential for higher oil prices if the conflict escalates again, which could keep inflation elevated. As a result, our economist expectc the spread could narrow to around 75bps, or around 100bps if BI decides to raise the policy rate by another 25bps.
From a sector and stock-selection perspective, we continue to favor the commodity sector, particularly MBMA, AMMN, and AADI, which could remain supported by favorable commodity dynamics. We also favor companies that are relatively less exposed to domestic inflationary pressures while having the potential to generate meaningful revenue from new growth engines. These include TPIA, supported by its sizeable revenue-generating assets in Singapore, and ISAT, which stands to benefit from the growing contribution of AI data-center-related revenues through Lintasarta and Zankore.