Goldman Sachs Constructive On IDR Bonds, But Mindful Of H1 Noise

The US bank is still constructive on IDR assets, particularly government bonds, but is is mindful of a potentially noisy H1. See below for more details.

Goldman Sachs: IDR weakened sharply through January on the combination of a stronger Dollar (as it has historically been one of the most sensitive Asia currencies to US rates) and an increase in domestic political noise ahead of the elections. Last week, news reports suggested that Finance Minister Sri Mulyani could be resigning, which prompted concerns about the incoming government potentially not maintaining fiscal prudence post-election. We think this is unlikely: we forecast a fiscal deficit of 2% (versus the government at 2.3%) in 2024 and we do not expect any amendment to the annual 3% of GDP fiscal deficit limit, as this would require extensive parliamentary proceedings, and this law has been active since 2004. IDR weakening through January took USD/IDR close to the levels of October 2023 when BI delivered a surprise hike to support the currency. With inflation already well within BI’s target range of 1.5-3.5%, this leaves the exchange rate as one of the main considerations for when and by how much BI can cut the policy rate in 2024. We think BI will wait for the Fed to cut rates before cutting in June (for a total of 75bps of cuts in this cycle to 5.25%) to maintain the rate differential with USD and support the currency.

With the BI remaining focused on currency developments and concerns about fiscal subsiding, IDR has managed to recoup some of its earlier losses. However, noise levels could increase again through the month as the country holds its largest elections in history with the first round on February 14th. Opinion polls suggest that none of the candidates will win outright in the 1st round and so there is likely to be a run-off round in June, which would keep election-related noise elevated through H1. In sum, with BI expected to cut policy rates, the current account in a smaller deficit than pre-Covid, the fiscal deficit within the cap, and portfolio inflows expected to pick up in H2 (once the Fed has started cutting and as election uncertainty diminishes) we think the macro fundamentals are conducive for IDR assets, especially government bonds.