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