19 November 2018
The Indonesian rupiah has rebounded 3 percent against the US dollar this year. Photo: Reuters
The Indonesian rupiah has rebounded 3 percent against the US dollar this year. Photo: Reuters

Why Indonesian market will continue to outperform this year

I predicted early this year that the Indonesian market is likely to outperform in Asia, and that is what has happened.

The rupiah, stocks and local-currency bonds have all performed well.

However, can the rally be sustained, or is it just a temporary blip in a bear market?

Money has been flowing back to the Indonesian market in recent weeks, which has bolstered the local currency and provided room for interest rate cuts.

However, many investors remain skeptical.

First of all, most Indonesian companies still report falling earnings per share in local-currency terms.

Financial and consumer stocks have suffered the most.

Second, the return on equity (ROE) of local companies has tumbled to the lowest in a decade.

The falling ROE has rippled into many sectors, not just commodity firms. This can be attributed to slower income growth and soaring labor costs.

Also, Indonesia still grapples with double deficits: the fiscal deficit and the current account deficit.

The current account deficit has declined to US$18 billion, about 2 percent of the country’s gross domestic product.

The fiscal deficit has expanded to nearly 3 percent of GDP.

Indonesia is heavily dependent on foreign investment, and net inflows from foreign investors are critical for the local equity market.

As a result, the Indonesian stock market bore the brunt when foreign investors pulled money out in the wake of the US Federal Reserve’s interest rate liftoff. The local market closed lower last year.

In addition, plunging prices of various commodities, like oil, gas, coal, palm oil and rubber, have caused a significant shock to the local economy.

Nevertheless, I’m still positive on the Indonesian market this year, for seven reasons.

First, the price of crude oil has shown signs of bottoming out recently after touching multi-year lows. That would help stabilize other commodity prices. The worst impact of commodity turmoil on Indonesia’s current account is behind us.

Second, the government can reduce the price of fuel given that oil prices are hovering near a bottom. That’s good news for low- and medium-income consumers.

It’s estimated that the local gasoline price may be cut to 5,500 Indonesian rupiah (42 US cents) per liter from 7,400 rupiah, if Brent crude remains at US$40 per barrel.

Third, Indonesia is trying to open up its domestic market and allow private investors to fully own companies in 35 industries.

Tourism, which contributes 9 percent of GDP, is one of these sectors. The sector provides 8-9 percent of the country’s jobs.

Singapore, Malaysia, China, Australia and Japan are the top five sources of tourists. Local authorities have been stepping up their efforts as the number of Chinese tourists has surged in recent years.

Fourth, the Indonesian government intends to implement a controversial tax amnesty plan to expand its tax revenue.

As in many other developing countries, tax evasion is quite rampant in Indonesia. The move would not only boost tax revenue immediately but also lure local residents to pull overseas money back into the country.

Fifth, the country is likely to accelerate its infrastructure projects. Last year, Indonesia merged its public works and housing ministries.

The new government’s budget plan was passed in October last year. Infrastructure spending has shown good progress in recent months.

Sixth, company earnings have already hit bottom. Some cyclical consumer firms may upgrade their profit forecasts, and telecom stocks have bright prospects as well.

Seventh, the Indonesian central bank cut interest rates by 0.25 percent last month and reduced the reserve requirement ratio by 1 percentage point.

As the Fed is expected to take a cautious stance in further raising rates, the rupiah has rebounded 3 percent against the US dollar so far this year.

This article appeared in the Hong Kong Economic Journal on March 7.

Translation by Julie Zhu

[Chinese version 中文版]

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Chief Investment Officer at Allianz Global Investors, Asia Pacific

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