Indonesia's twin budget and current account deficits are threatening to "go wild" once again, and soon, warns Société Générale.
"The Indonesian government has sounded the victory bugle a tad too early, it seems," Kunal Kumar Kundu, economist at Société Générale wrote in a note.
A ban on mineral ore exports, lower-than-expected coal and palm oil exports and falling oil production are set to exacerbate the country's deficits, according to the bank.
The bank revised its current account deficit target to 3 percent of gross domestic product (GDP) from 2.8 percent and its budget deficit target to 2.5 percent from 2 percent. It also reduced its annual GDP forecast to 5.2 percent from 5.3 percent.
Southeast Asia's largest economy was hit hard by an exodus of foreign capital from its asset markets last summer when the Federal Reserve signaled it would scale back monetary stimulus. It was punished by investors due to structural weaknesses in its economy, in particular its wide current account gap that makes its heavily reliant on foreign capital for funding.
A widening of its current account and fiscal deficits puts the country at risk further capital outflows and financial stress.
Current account dynamics
Indonesia's current account – the broadest measure of trade in goods and services, which has been in deficit since late 2011 – could come under further pressure owing to a few factors.
A key factor is the government's move in January to ban exports of raw mineral ores in a move to promote domestic processing – which has already started to bite, said Kundu.
"The result of the ban is that exports of nickel and copper ore have stalled completely, while exports of bauxite have fallen to a trickle," he said.
Meantime, coal – the country's biggest mining export – is also experiencing a notable slowdown not only in terms of volume but also value due to weak prices. During the first four months of the year, Indonesia's total coal exports totaled $7.4 billion, compared with $8.5 billion in the same period a year earlier. Coal exports are likely to remain weak as the government has decided to cap coal production to support prices, he said.
Furthermore, palm oil – another major export – faces headwinds as external demand falters.
Finally, Indonesia's crude oil production is likely to fall short of budget estimates, which could raise demand for imported fuel. Crude oil production is forecast be around 800,000 barrels per day (bpd) against the initial budget expectation of 870,000 bpd.
"The weak current account balance is more a result of structural weakness than cyclical factors – under-development of technology intensive industries (leading to high import dependence), growing dependence on commodity exports (concomitantly falling exports of manufactured products) and substantial price subsidies for gasoline (which leads to rising imports of crude oil as domestic consumption spurts," Kundu said.
On the budget front, the government is at risk of breaching its target on fuel subsidies, which could worsen the deficit.
Fuel subsidies are among Indonesia's biggest budget expenditures – greater than healthcare and infrastructure spending.
"The biggest bane for Indonesia is its weak fiscal health – a manifestation of the hugely subsidized domestic gasoline price that engenders a sharp rise in demand while domestic oil production continues to falter," Kundu said.
The government, which has consistently underestimated the extent of fuel subsidies over the years, recently revised its 2014 fuel subsidy expectation to 285 trillion rupiah from its original target of 210 trillion rupiah.
"We feel that even the revised target will likely be breached and could touch the 300 trillion rupiah mark," Kundu said.