Boom and bust in Indonesian stock market

By David Chang

JAKARTA (JP): This will be a landmark year in Indonesian history -- remembered as a year of boom and bust. The new and fast-growing class of affluent Indonesians, created out of a euphoric and vibrant economy that lasted through the first semester of 1997, has been reduced to destitution even before the year was over.

The Jakarta Stock Exchange (JSX) Composite Index, perhaps the best indicator of the Indonesian economy and business confidence, rose to an all-time high of 741 points in July. The elation, however, was short lived.

Following the flotation of the Thai baht and the Philippine peso in July, the government finally decided to float the Indonesian rupiah on Aug. 14, after relentless attacks on its currency.

Unfortunately, neither the government nor the private sector was prepared for the incessant volatility of the rupiah which had a dilapidating effect on the Indonesian economy.

Initially, most economists suggested that the sporadic battering of the Thai baht and Philippine peso was unlikely to spread to Indonesia, as there were distinctive differences in the economic fundamentals between the countries. For instance, Indonesia prided itself on a relatively lower current account deficit to GDP ratio of 3.4 percent in 1997, which was better than Thailand's 5.4 percent or Malaysia's 5 percent. However, as the invisible speculators continued their systematic blitz on Southeast Asia, analysts started to focus on the similarities of these economies.

Consequently, doubts started to surface over the sustainability of the region's high economic growth rates and the value of their domestic currencies. There were concerns of Indonesia's fragile financial sector. The high loan growth of the banking sector gave rise to anxiety over nonperforming loan levels and excessive exposure to the property sector.

The unexpected initial attack on the Indonesian rupiah, unfortunately, stirred up a hornets' nest as it created panic among local companies which had significant foreign loans with unhedged positions. This started the first wave of a dollar- buying frenzy, which weakened the rupiah further.

The Indonesian government's response was to tighten rupiah liquidity by raising the Central Bank SBI (short-term note issue) from 11 percent (for a one-month SBI) to 30 percent. This pushed overnight rates up above 100 percent for a few days.

As banks frantically competed for funds to maintain their liquidity, deposit rates were raised to between 25 percent and 80 percent, while lending rates were adjusted to between 30 percent and 45 percent. The effect of these interest rate hikes on the capital market was, likewise, sharp and swift. The JSX Composite Index plunged by 32 percent, or 228 points, to 494 by the end of August -- a period of only one month. In addition, the secondary and primary bond market grounded to a halt with these steep increases in deposit rates and tight liquidity.

As a result, Indonesians began to wake up to the fact that their economy was now trapped in a descending spiral caused by its currency weakness, increasing foreign liability, decreasing corporate earnings and diminishing investor confidence, in addition to the political complications relating to speculation on President Soeharto's physical well-being.

The government tried to restore investor confidence in the financial market and the Indonesian rupiah by revising the budget, liberalizing foreign share ownership, strengthening the banking industry and raising the luxury sales tax on several goods.

This pushed the JSX Composite Index up 12 percent in four days to 600 points on Sept. 8. Since then, the market crept down to 360 points as of Dec. 12, which was a decline of 51 percent from its peak this year and 43 percent from the year-end of 1996.

This is despite US$30 billion promised in financial aid from the IMF, World Bank, ADB, and other bilateral donors.

In 1998, the stockmarket may be affected by three key variables: the rupiah, interest rates and political stability. If these variables stabilize, the stockmarket should recover within 12 months.

There is a positive correlation between the rupiah and the JSX Composite Index, as was the case in the Mexican peso depreciation in December 1994. The peso depreciated by about 35 percent to 4.6 pesos per $1, and a further 26 percent in January 1995. This was accompanied by a 40 percent decrease in Mexico's Bolsa index to 1500 points in February 1995. While the Mexican peso stabilized, the Mexican stockmarket recovered in about eight months to 2500 points in August 1995.

Unless the rupiah stabilizes against the U.S. dollar, the Indonesian stock market will continue to reflect the volatility of its exchange rate. The stock market requires a stable domestic currency. When the government is able to stabilize the rupiah, the stock market should be able to turn around in less than a year.

The rupiah will stabilize only if there are no major upheavals in the political arena. At this stage, major disorder seems unlikely since it is expected that Golkar will push ahead with President Soeharto's nomination for reelection.

Due to concern over the smooth transition of leadership, the candidates for the vice presidential election in 1998 will be crucial. As in the past, although no clear indication of the vice presidential candidate has yet been disclosed, it does not mean that there are no plans for a smooth transition of leadership. In keeping with the tradition of wayang kulit (puppet show), the audience must wait for the puppet master to bring out the characters onto the stage. This, perhaps, is a ubiquitous aspect of Indonesian culture which is not about to change overnight.

The writer is the director of research of PT Trimegah Securities.