Here's what Indonesia must worry about in the next 12 months

Amid widening current account deficit and weak exports, Indonesia should be cautious about three main points, says Macquarie Securities.

Rising rates. A combination of weak exports and a strong domestic economy is causing the trade and current account deficit to widen. Trade deficit, which looks to be quite persistent, is making it harder for BI to maintain rupiah stability. BI‟s tone in the last policy meeting, however, is turning more cautious, aiming to bring the current account deficit to a more „sustainable‟ level and control rupiah stability in the process.

Government pump priming. The government wants to keep the economy strong ahead of 2014 elections, and rightly so because it helps to collect votes. It is no surprise that the government does not expect a slowdown in the economy with real GDP growth of 6.4-6.6% in 2H12 and 6.8-7.2% in 2013 supported by more government spending/stimulus. President SBY has also just signed the long-waited implementation regulations for land acquisitions to further jump start public infrastructure spending.

Prepare for volatility. Foreign inflow into local currency government bonds was strong in July, but weak overall in the past year. Yields on the 10-year bonds have fallen to below 6.0%, following, in our view, the downward move in US Treasury yields. However the 10-year US Treasury at 1.6% is approaching zero bound, which means much less support for the Indonesian bond market and greater volatility ahead.

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