My overall conclusion is the demise of the emerging market growth story is premature and the current sell-off has provided some highly attractive entry points.
However, with a politician’s hat on, there are clearly risks on the horizon. Top of the list would be poor economic management by the Indonesian and Thai central banks, and credit growth that has run above GDP rates across the region for too long, fuelled by cheap money.
I arrived in Jakarta at a time when investor concerns about economic imbalances in Indonesia were prevalent and rapid outflows were occurring. Despite strong secular arguments for the country, I believe Indonesia displays many late-cycle symptoms – a stubborn current account deficit, a commodity-based economy that is closely tied to China and an elongated property and construction boom.
The dilemma for investors is whether the current sell-off mirrors similar sell-offs in 2012 and 2011, triggered by risk-off events elsewhere in Europe/Greece, in which case the market should recover quickly, or whether it represents the start of a more prolonged period of underperformance.
The market is dominated by foreign fund flows and either discussion of or action on the tapering of monetary easing programmes will likely lead to ongoing US dollar strength and therefore further outflows and stock market weakness.
Challenges ahead
Indonesia has the second-worst current account deficit (in Asia ex-Japan excluding India) at -3.5% and a growing budget deficit problem. External debt is 5% of total debt, which is not problematic in itself but short-term debt accounts for close to 50% of foreign exchange reserves, which are now down to six months of import cover.
The government announced a surprise 25 basis point rise in interest rates the week before I arrived, shortly after comments from the central bank suggesting otherwise. Although the correct medicine has been administered, aggressive intervening in the foreign exchange market implies a haphazard monetary policy.
More importantly, the parliament finally approved a 45% increase in petrol prices and 25% for diesel. This occurred during my visit and mass demonstrations highlighted the contentious nature of this bill. This was vital in improving government finances and will go some way to reducing the current account deficit. There may be a short-term impact on growth and inflation will rise, but investors should welcome this news.
There will be an election next year in Indonesia, so while there may be some ‘gifts’ handed out in the run-up, tensions are likely to be heightened. Credit growth has run at unsustainable levels for the past five years relative to GDP growth, and loan-to-deposit ratios for the seven biggest banks now stand at 86%.
However, from a secular perspective the long-term structural story remains in place – the ratio of bank lending to GDP is only 33%, for example. Indonesia has come a long way since 1997 when external debt neared 70% of total debt.
