Share prices to gain after 22% loss<\/p>\n
By Teng Hong Joe<\/p>\n
JAKARTA (JP): The performance of the Jakarta Stock Exchange
\n(JSX), during the past year has been disappointing. From the
\nbeginning of the year through Dec. 19, the Jakarta Composite
\nIndex (JCI), lost approximately 22 percent. But it is important
\nto note that the JCI began the year with a 68 percent increase
\nfrom that in early 1993 and had recovered 104 percent from its
\nlow of 224.7 in October 1991.<\/p>\n
Since the history for performance of emerging markets in the
\nshort term is quite volatile and that trading in this market is
\nquite difficult, it is important to have a long term horizon.<\/p>\n
The average annual return on the JSX index since 1992 is 28.7
\npercent, which compares favorably with the average return on time
\ndeposits of 16 percent during the same period.<\/p>\n
Rising interest rates in the U.S. have been the major factor
\nbehind the poor performance of virtually all stock markets. The
\neffect of rising interest rates is three fold.<\/p>\n
First, investors will reconsider bonds or time deposits as a
\nsafer way to invest their money.<\/p>\n
Second, as a consequence, there is a sell-off of equities as
\nfund managers are raising cash in anticipation of redemptions by
\ninvestors.<\/p>\n
Third, the higher interest rates will impact economic activity
\nand corporate earnings. Given that Indonesia enjoys free foreign
\ncurrency traffic, and that the rupiah is more or less pegged to
\nthe U.S. dollar, interest rates in Indonesia have followed that
\nof the U.S. dollar.<\/p>\n
All markets in the region have been affected by higher
\ninterest rates. Compared to other markets in the region, the
\nperformance of the JSX has not been particularly bad.<\/p>\n
However, from time to time during the past year, the JSX has
\nunder-performed against its regional counterparts.<\/p>\n
There are a few domestic factors that need to be taken into
\nconsideration. Weak oil prices, higher than anticipated
\ninflation, political and social turmoil, the problems with the
\nstate banks, slowdown in non-oil export growth and too many IPOs
\nare factors that have had a negative impact on investor
\nsentiment.<\/p>\n
The weakness in oil prices negatively influenced investor
\nsentiments during the first half of the year. The government
\nprojected an average oil price of US$16 per barrel in its current
\nbudget.<\/p>\n
However, during the first quarter of the current fiscal year,
\noil prices were considerably below $16, which sparked fear among
\ninvestors of a budget deficit. The oil price has recovered in the
\nsecond half of 1994. At the moment, oil prices are $16.35 per
\nbarrel, while the average price during the current fiscal year
\nreached $16.09.<\/p>\n
The high inflation rate during the year has been a major
\nconcern for investors. Inflation in 1994 is expected to reach 9.6
\npercent, which is almost equal to the 9.7 percent in 1993.<\/p>\n
Too much rain in the first half of the year, and too little
\nrain in the second half are just partial excuses for the high
\ninflation.<\/p>\n
There are a number of other causes behind the persistently
\nhigh inflation that requires attention.<\/p>\n
Poor infrastructure remains to be one of the main causes of
\ninflationary pressures. Nevertheless, compared to just four years
\nago, the infrastructure has greatly improved. The speed at which
\nmore roads, electricity and telephone lines are coming on line is
\na clear sign of the government's commitment to tackle the
\ninflationary pressures caused by poor infrastructure.<\/p>\n
Further improvements over the next five to ten years are
\nnecessary to attract foreign direct investments. The government's
\npolicy to build an infrastructure which is sufficient to attract
\nmore foreign direct investments, will be one of the key factors
\nbehind economic growth over the next five years.<\/p>\n
We have no doubt that this policy will be given priority
\nduring years of slower economic growth, which makes the
\ninfrastructure resilient against a possible economic slowdown.<\/p>\n
The wage increase this year and next year have also ignited
\nfears of inflation because of concerns that such rises do not
\ncoincide with rises in productivity.<\/p>\n
The sharp rise of 27 percent for the average minimum wage in
\n1994 and another 10 percent in 1995 seems justified and such
\nincreases are important to minimize social unrest.<\/p>\n
However, the poor export performance of Indonesia's garment
\nindustry partly illustrates the devastating effect of wage
\nincreases without increases in productivity.<\/p>\n
Indonesia needs to continue addressing this matter or else it
\nwill be involved in a continued wage-price spiral, which could
\nwipe out the country's export competitiveness.<\/p>\n
Virtually all commodity prices have gone up sharply in 1994,
\nresulting in further inflationary pressures. Being a country with
\nplenty of natural resources, Indonesia benefits from this strong
\npositive leverage.<\/p>\n
On the other hand, the manufacturing industry is faced with
\nsqueezes in margins, caused by a lack of vertical integration, or
\nby an inadequate supply of raw material.<\/p>\n
We are projecting inflation in 1995 at 8.5 percent. Higher
\naverage commodity prices, higher wages, stronger economic growth,
\nfurther cuts in government subsidies, a 10 percent wage rise and
\nperiodical adjustments of electricity rates will contribute to
\nnext year's inflation.<\/p>\n
The periodical unrest on the political front in 1994 had a
\nnegative impact on the stock market. An increasing number of
\ninvestors are viewing such unrest as "growing pains" in the
\nprocess of Indonesia's political maturing. We could not agree
\nmore.<\/p>\n
We feel that whenever the market might react again to
\npolitical unrest, investors should view these as buying
\nopportunities.<\/p>\n
The new cabinet with its strong presence of highly skilled
\nMoslem technocrats has overcome initial doubts from investors
\nregarding its ability to guide Indonesia into its next 25 years
\nof development. It has gained strong international support for
\nits deregulation and willingness to mention and address
\nfundamental problems.<\/p>\n
The Bapindo case showed a surprising level of openness, and as
\nwe will explain later, at the end of the day it did not damage
\ninvestors' perception on Indonesia too badly.<\/p>\n
The on-going deregulation, aimed at attracting more foreign
\ndirect investments, has enhanced the fact that Indonesia is one
\nof the most attractive places in Southeast Asia for foreign
\ndirect investment, and as a result, Indonesia has achieved record
\nforeign investment commitments in 1994.<\/p>\n
The much discussed Bapindo case has shown us three important
\nfacts, unfortunately at considerable cost to the country.<\/p>\n
First, the openness surrounding the Bapindo case and the firm
\nactions taken against the individuals involved will, hopefully,
\nhave their preventive effect. This case illustrates the
\ngovernment's policy to be more open and to gradually fight
\ncorruption.<\/p>\n
Second, by backing the Bapindo's deficits, the Indonesian
\ngovernment has shown its commitment to honor the liabilities of
\nstate-owned companies. This is important because it contributes
\nto Indonesia's reputation as a borrower in international capital
\nmarkets. As a result, even with all the negative publicity that
\nIndonesia underwent, interest rates for Indonesia and for
\nIndonesian private companies have not risen dramatically.<\/p>\n
Thirdly, it has now become clear that the state banks need to
\nimprove their managements and balance sheets to meet
\ninternational banking standards and thus prevent them from
\nfurther deterioration.<\/p>\n
It is interesting to note that the private banks have seen
\ntheir market share rise from roughly 20 percent in 1988 to 50
\npercent in 1994. As the more efficient and professional private
\nbanks increase their market share over state banks, the quality
\nof Indonesia's financial system as a whole will improve, which in
\nthe long term will ease domestic interest rates.<\/p>\n
Non-oil exports have been a major contributor to growth in
\n1993 and 1992. Unfortunately, loss of competitiveness and
\nweakness in prices of major export products have caused non-oil
\nexport growth in 1994 to decline further to roughly 10 percent,
\ncompared to 15 percent in 1993 and 28 percent in 1992.<\/p>\n
A combination of factors, several of which have been mentioned
\nabove, are responsible for the lackluster export performances in
\n1994. The disappointing performances of plywood, textile and
\ngarment exports are generally seen as the main cause of
\ndecreasing non-oil export growth.<\/p>\n
Also the absence of significant productivity improvements,
\nhigh, hidden costs and lack of vertical integration have caused
\nIndonesia to lose its competitiveness to other Asian countries.<\/p>\n
Given the recent establishment of more upstream industries, we
\nthink Indonesia will regain part of its export share over the
\nnext two to three years.<\/p>\n
Going into 1995, the outlook for the JSX is favorable. We
\nexpect the gross domestic products (GDP) to grow by seven
\npercent, compared to 6.8 percent in 1994. The huge investments
\nin the infrastructure, the realization of record foreign direct
\ninvestment commitments of $32 billion in 1994 and the effect of
\ntax reforms are main contributors to a higher GDP growth.<\/p>\n
Corporate earnings growth will maintain momentum. In 1994, the
\nearnings of the 50 companies that make up the GT-DBS 50 index are
\nestimated to increase by roughly 36 percent and earnings per
\nshare (EPS) by 24 percent. For 1995 we are projecting corporate
\nearnings to grow by 26 percent and EPS by 25 percent.<\/p>\n
On the negative side, further rises in interest rates will be
\nthe major threat for a recovery of the stock market in 1995.
\nHowever, we expect interest rates to ease slightly in the second
\nhalf of next year.<\/p>\n
Although the huge flow of new issues has been and will be
\nsoaking up a large amount of funds, we consider this factor to be
\npositive for the Indonesian capital market. The flow of new
\nissues increases liquidity in the market, while at the same time
\nthe market is gaining depth.<\/p>\n
With additional companies representing more sectors coming to
\nthe market, the stock market will better represent the Indonesia
\neconomy, and offer investors better exposure to the Indonesian
\neconomy.<\/p>\n
Given the strong spending in infrastructure developments by
\nthe government and private sectors, companies with an exposure to
\ninfrastructure will offer interesting investment opportunities.
\nDemand for infrastructure-related products and services will
\nremain strong over the next five to ten years. While in times of
\neconomic downturn, such demand will be relatively resilient.<\/p>\n
The acceleration in GDP growth, the effect of the
\nimplementation of new investments, tax reforms which have lowered
\nthe effective tax rate, 10 percent wage rises for minimum wage
\nlevels and strong consumer confidence will continue to benefit
\ncompanies with exposures to the consumer sector in 1995.<\/p>\n
In emerging countries like Indonesia, consumer companies can
\npost growth figures of between at least 10 to 20 percent per
\nannum. With such bright prospects, investors are willing to pay
\npremium multiples for consumer stocks. Now that a number of
\nconsumer stocks are trading 10 to 20 percent below their recent
\nhighs, investors should increase their exposure to consumer
\nstocks of which some are attractively priced in relation to the
\ntheir projected EPS growth for 1995 and 1996.<\/p>\n
During 1994, foreign investors continued to dominate the
\ntrading on the JSX. It should be mentioned that in the past year,
\nactivities from local institutional and private investors have
\nincreased significantly.<\/p>\n
After the implementation of rules for pension fund
\ninvestments, that were released in April 1993, a number of local
\npension funds have started to invest in the stock market. At the
\nmoment, we estimate the total funds under management by local
\npension funds at Rp 8 trillion.<\/p>\n
We expect that over the next few years, local pension funds
\nwill become more accustomed to investing in the capital market,
\nand hence increase their exposure. Potentially, the Indonesian
\npension funds could become a major market force in the next five
\nto eight years. The trend is very positive because pension funds
\nwith long-term objectives are usually the type of investor that
\ncan benefit from short term technical corrections like the ones
\nthat we have seen in the past few weeks.<\/p>\n
Local private investors seem to have returned to the market,
\nalthough it should be mentioned that their investment strategy
\nremains highly speculative and their time horizon very limited.
\nOnce open-end investment funds become available in 1995, private
\ninvestors should seriously consider investing in the stock market
\nthrough such funds, and enjoy the benefits of professional fund
\nmanagement.<\/p>\n
In conclusion, we believe that the JSX will perform well in
\n1995, and investors should be buying now. Supported by a strong
\nmomentum in economic growth and corporate earnings, we believe
\nthat both local and foreign investors will be attracted by
\nIndonesia's strong growth momentum and promising long term
\nprospects.<\/p>\n
After the recent weaknesses, valuations are now highly
\nattractive. The GT-DBS 50 index is currently trading at 15 times
\nits prospective earnings, compared to roughly 18 times at the
\nbeginning of the year, leaving ample room for attractive capital
\ngains that could easily surpass 20 percent.<\/p>\n
Teng Hong Joe is the General Manager of Business Development
\nof PT Gadjah Tunggal DBS Securities in Jakarta.<\/p>\n
Windows A: In trading in such emerging markets as the Jakarta Stock
\nExchange it is important to have a long time horizon.<\/p>\n
Window B: Although the huge flow of new issues has been and will be
\nsoaking up a huge amount of funds, we consider this factor to be
\npositive for the capital market.<\/p>\n
Window C: Demand for infrastructure-related products and services will
\nremain strong over the next five to 10 years. While in times of
\neconomic downturn such demand will be relatively resilient.<\/p>",
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