Indonesia market outlook: Another better year ahead

Indonesia market outlook: Another better year ahead

David Chang

This time last year, I predicted that the stock market in 2004 would be better than in the previous year despite the political concerns, even after being one of the strongest performers in Asia for 2003. That has proven to be right as the Jakarta Stock Exchange composite index has since climbed 36 percent from 692 points at end-2003 to 939 as of Dec. 15, 2004. Investors who have profited from the bull run this year will no doubt ask themselves whether it is time to cash out any time soon, with the stock market at such unprecedented highs.

The market has made an ostensibly impressive recovery in 2004 due to a cheap market valuation. I believe that another better year lies ahead. If the economy and corporate earnings perform as expected, and the political environment remains stable, then the bull market should continue, albeit at a more controlled pace, at least for the next 18 months.

There are various reasons for my current optimism in the market. Susilo Bambang Yudhoyono's victory as Indonesia's first directly elected president last July, over Megawati Soekarnoputri was not widely expected, but it did not dampen market sentiment. Although Megawati was credited for doing a reasonably good job for the Indonesian economy during her term, foreign investors were quick to envisage the positive benefits for the country when Susilo unexpectedly won the people's popular mandate.

The presidential and general election results had been one of the most critical factors, which influenced the Indonesian financial market in 2004. For many years, political risk has played a dominant role in depressing the domestic currency, equity and bond prices, while relatively high interest rates maintain a severe constraint on corporate earnings growth. As a result, Indonesia has suffered from the consequences of high inflation and low economic growth.

However, the economic outlook for Indonesia is expected to turn around over the next few years under the new leadership of Susilo. Indonesia's GDP growth should improve modestly from 4.8 percent in 2004 to 5.4 percent in 2005, based on conservative assumptions and supported by robust growth during the second and third quarters of 2004.

GDP growth was 5.0 percent in Q3 2004, which is slightly higher than expectations of 4.6 percent, and the 4.5 percent growth in Q2. The growth was mainly boosted by domestic consumption, which accounted for 73 percent of GDP growth. A stronger rupiah and lower interest rate environment should continue to enhance the economy.

As part of the government's election promise to push growth rate up to 7 percent by 2009, there are ambitious plans for investment in infrastructure. In the next five years, the government is expected to raise between Rp 700 trillion (US$75 billion) and Rp 1,000 trillion (US$110 billion), or about one third of its GDP from local and foreign investors to finance infrastructure projects to build roads, railways, ports, airports, power plants, telecommunication facilities, gas distribution, water plants, irrigation facilities, housing and other crucial infrastructure.

About Rp 200 trillion could be funded by the state budget, another Rp 200 trillion by local banks but the remainder is expected to be financed by local and foreign institutional investors, including global financial institutions such as the World Bank and the Asian Development Bank. More investments opportunities will thus be available for investors and lenders over the next few years.

Foreign investors have been particularly impressed by Susilo's focus to reduce government corruption and to improve domestic security. The corruption issue has been particularly awkward for the government since Transparency International recently ranked Indonesia as among the most-corrupt countries in the world. This was probably the reason for Susilo's decision to make it mandatory for Cabinet ministers and senior government officials to utter public oaths and sign "political contracts" against corruption.

A gradual reduction in institutionalized corruption could ensure more efficient allocation of economic resources, and a more equitable distribution of wealth among the people who have remained one of the poorest (in terms of GDP per capita) in this region. In the long run, this should provide a more stable social environment and stronger economy. The government has since demonstrated an added zeal in pursuing and prosecuting the perpetrators responsible for the Bali and Kuningan bombings.

This would help alleviate fears that Indonesia, being the biggest Muslim country in the world, could become a terrorist refuge for future attacks against Western interests within the region. With a significant reduction in risk premium, Indonesian asset values should climb rapidly in the short term.

Susilo is likely to be judged on his performance during the first 100 days of office in Q1 2005, and would be perceived to have "acted" on the main election pledges to improve the economy, enhance domestic security and reduce corruption. It is therefore unlikely that his political opponents would be able to find major issues which could pose a serious political threat for Susilo during that period.

However, the president is expected to face a serious leadership challenge with a significant fuel price increase planned for next year, when shrewd political opponents could incite ferocious public antagonism against the government which would ultimately be detrimental to the state budget deficit. With rising unemployment (currently over 9 percent), political opponents could harness the massive dissenting population, still living in poverty, to protest and weaken the government.

Due to higher oil prices, the fuel subsidy is estimated to reach Rp 59 trillion in 2004, from Rp 20 trillion in the previous year. The sudden removal of oil subsidies are likely to cause strong inflationary and interest rate pressures on the economy. Although higher oil prices would increase oil subsidies and hence worsen the budget deficit, the government is hoping that this impact may be mitigated by increased revenue from the oil and gas industry.

The recent deregulation of the oil and gas sector is expected to boost investment in the sector. Investment on oil exploration is expected to more than triple to US$779 million in 2004, according to the Energy and Mining Resources Ministry. This is necessary to boost production among major oil companies, due to gradual depletion of oil reserves in the current aging oil fields. The government is expected to sign 46 new oil and gas contracts worth more than US$4.2 billion.

The International Monetary Fund (IMF) and other international financial institutions are currently upbeat on the Indonesian economy. During its recent visit, the IMF summed up its view on Indonesia that current GDP growth is "below potential", economic performance has continued to improve and financial markets have responded favorably. With a relatively stable political and social environment, Indonesia's economic growth fundamentals are currently the best that we have seen since the economic crisis in 1997.

The Indonesia market outlook for 2005 is promising, and could shape up to become one of the most exciting emerging markets in the world.

The writer is a director in securities company PT Paramitra Alfa Sekuritas