Boom and bust in Indonesian stock market

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.