Share prices to gain after 22% loss

Share prices to gain after 22% loss

By Teng Hong Joe

JAKARTA (JP): The performance of the Jakarta Stock Exchange
(JSX), during the past year has been disappointing. From the
beginning of the year through Dec. 19, the Jakarta Composite
Index (JCI), lost approximately 22 percent. But it is important
to note that the JCI began the year with a 68 percent increase
from that in early 1993 and had recovered 104 percent from its
low of 224.7 in October 1991.

Since the history for performance of emerging markets in the
short term is quite volatile and that trading in this market is
quite difficult, it is important to have a long term horizon.

The average annual return on the JSX index since 1992 is 28.7
percent, which compares favorably with the average return on time
deposits of 16 percent during the same period.

Rising interest rates in the U.S. have been the major factor
behind the poor performance of virtually all stock markets. The
effect of rising interest rates is three fold.

First, investors will reconsider bonds or time deposits as a
safer way to invest their money.

Second, as a consequence, there is a sell-off of equities as
fund managers are raising cash in anticipation of redemptions by
investors.

Third, the higher interest rates will impact economic activity
and corporate earnings. Given that Indonesia enjoys free foreign
currency traffic, and that the rupiah is more or less pegged to
the U.S. dollar, interest rates in Indonesia have followed that
of the U.S. dollar.

All markets in the region have been affected by higher
interest rates. Compared to other markets in the region, the
performance of the JSX has not been particularly bad.

However, from time to time during the past year, the JSX has
under-performed against its regional counterparts.

There are a few domestic factors that need to be taken into
consideration. Weak oil prices, higher than anticipated
inflation, political and social turmoil, the problems with the
state banks, slowdown in non-oil export growth and too many IPOs
are factors that have had a negative impact on investor
sentiment.

The weakness in oil prices negatively influenced investor
sentiments during the first half of the year. The government
projected an average oil price of US$16 per barrel in its current
budget.

However, during the first quarter of the current fiscal year,
oil prices were considerably below $16, which sparked fear among
investors of a budget deficit. The oil price has recovered in the
second half of 1994. At the moment, oil prices are $16.35 per
barrel, while the average price during the current fiscal year
reached $16.09.

The high inflation rate during the year has been a major
concern for investors. Inflation in 1994 is expected to reach 9.6
percent, which is almost equal to the 9.7 percent in 1993.

Too much rain in the first half of the year, and too little
rain in the second half are just partial excuses for the high
inflation.

There are a number of other causes behind the persistently
high inflation that requires attention.

Poor infrastructure remains to be one of the main causes of
inflationary pressures. Nevertheless, compared to just four years
ago, the infrastructure has greatly improved. The speed at which
more roads, electricity and telephone lines are coming on line is
a clear sign of the government's commitment to tackle the
inflationary pressures caused by poor infrastructure.

Further improvements over the next five to ten years are
necessary to attract foreign direct investments. The government's
policy to build an infrastructure which is sufficient to attract
more foreign direct investments, will be one of the key factors
behind economic growth over the next five years.

We have no doubt that this policy will be given priority
during years of slower economic growth, which makes the
infrastructure resilient against a possible economic slowdown.

The wage increase this year and next year have also ignited
fears of inflation because of concerns that such rises do not
coincide with rises in productivity.

The sharp rise of 27 percent for the average minimum wage in
1994 and another 10 percent in 1995 seems justified and such
increases are important to minimize social unrest.

However, the poor export performance of Indonesia's garment
industry partly illustrates the devastating effect of wage
increases without increases in productivity.

Indonesia needs to continue addressing this matter or else it
will be involved in a continued wage-price spiral, which could
wipe out the country's export competitiveness.

Virtually all commodity prices have gone up sharply in 1994,
resulting in further inflationary pressures. Being a country with
plenty of natural resources, Indonesia benefits from this strong
positive leverage.

On the other hand, the manufacturing industry is faced with
squeezes in margins, caused by a lack of vertical integration, or
by an inadequate supply of raw material.

We are projecting inflation in 1995 at 8.5 percent. Higher
average commodity prices, higher wages, stronger economic growth,
further cuts in government subsidies, a 10 percent wage rise and
periodical adjustments of electricity rates will contribute to
next year's inflation.

The periodical unrest on the political front in 1994 had a
negative impact on the stock market. An increasing number of
investors are viewing such unrest as "growing pains" in the
process of Indonesia's political maturing. We could not agree
more.

We feel that whenever the market might react again to
political unrest, investors should view these as buying
opportunities.

The new cabinet with its strong presence of highly skilled
Moslem technocrats has overcome initial doubts from investors
regarding its ability to guide Indonesia into its next 25 years
of development. It has gained strong international support for
its deregulation and willingness to mention and address
fundamental problems.

The Bapindo case showed a surprising level of openness, and as
we will explain later, at the end of the day it did not damage
investors' perception on Indonesia too badly.

The on-going deregulation, aimed at attracting more foreign
direct investments, has enhanced the fact that Indonesia is one
of the most attractive places in Southeast Asia for foreign
direct investment, and as a result, Indonesia has achieved record
foreign investment commitments in 1994.

The much discussed Bapindo case has shown us three important
facts, unfortunately at considerable cost to the country.

First, the openness surrounding the Bapindo case and the firm
actions taken against the individuals involved will, hopefully,
have their preventive effect. This case illustrates the
government's policy to be more open and to gradually fight
corruption.

Second, by backing the Bapindo's deficits, the Indonesian
government has shown its commitment to honor the liabilities of
state-owned companies. This is important because it contributes
to Indonesia's reputation as a borrower in international capital
markets. As a result, even with all the negative publicity that
Indonesia underwent, interest rates for Indonesia and for
Indonesian private companies have not risen dramatically.

Thirdly, it has now become clear that the state banks need to
improve their managements and balance sheets to meet
international banking standards and thus prevent them from
further deterioration.

It is interesting to note that the private banks have seen
their market share rise from roughly 20 percent in 1988 to 50
percent in 1994. As the more efficient and professional private
banks increase their market share over state banks, the quality
of Indonesia's financial system as a whole will improve, which in
the long term will ease domestic interest rates.

Non-oil exports have been a major contributor to growth in
1993 and 1992. Unfortunately, loss of competitiveness and
weakness in prices of major export products have caused non-oil
export growth in 1994 to decline further to roughly 10 percent,
compared to 15 percent in 1993 and 28 percent in 1992.

A combination of factors, several of which have been mentioned
above, are responsible for the lackluster export performances in
1994. The disappointing performances of plywood, textile and
garment exports are generally seen as the main cause of
decreasing non-oil export growth.

Also the absence of significant productivity improvements,
high, hidden costs and lack of vertical integration have caused
Indonesia to lose its competitiveness to other Asian countries.

Given the recent establishment of more upstream industries, we
think Indonesia will regain part of its export share over the
next two to three years.

Going into 1995, the outlook for the JSX is favorable. We
expect the gross domestic products (GDP) to grow by seven
percent, compared to 6.8 percent in 1994. The huge investments
in the infrastructure, the realization of record foreign direct
investment commitments of $32 billion in 1994 and the effect of
tax reforms are main contributors to a higher GDP growth.

Corporate earnings growth will maintain momentum. In 1994, the
earnings of the 50 companies that make up the GT-DBS 50 index are
estimated to increase by roughly 36 percent and earnings per
share (EPS) by 24 percent. For 1995 we are projecting corporate
earnings to grow by 26 percent and EPS by 25 percent.

On the negative side, further rises in interest rates will be
the major threat for a recovery of the stock market in 1995.
However, we expect interest rates to ease slightly in the second
half of next year.

Although the huge flow of new issues has been and will be
soaking up a large amount of funds, we consider this factor to be
positive for the Indonesian capital market. The flow of new
issues increases liquidity in the market, while at the same time
the market is gaining depth.

With additional companies representing more sectors coming to
the market, the stock market will better represent the Indonesia
economy, and offer investors better exposure to the Indonesian
economy.

Given the strong spending in infrastructure developments by
the government and private sectors, companies with an exposure to
infrastructure will offer interesting investment opportunities.
Demand for infrastructure-related products and services will
remain strong over the next five to ten years. While in times of
economic downturn, such demand will be relatively resilient.

The acceleration in GDP growth, the effect of the
implementation of new investments, tax reforms which have lowered
the effective tax rate, 10 percent wage rises for minimum wage
levels and strong consumer confidence will continue to benefit
companies with exposures to the consumer sector in 1995.

In emerging countries like Indonesia, consumer companies can
post growth figures of between at least 10 to 20 percent per
annum. With such bright prospects, investors are willing to pay
premium multiples for consumer stocks. Now that a number of
consumer stocks are trading 10 to 20 percent below their recent
highs, investors should increase their exposure to consumer
stocks of which some are attractively priced in relation to the
their projected EPS growth for 1995 and 1996.

During 1994, foreign investors continued to dominate the
trading on the JSX. It should be mentioned that in the past year,
activities from local institutional and private investors have
increased significantly.

After the implementation of rules for pension fund
investments, that were released in April 1993, a number of local
pension funds have started to invest in the stock market. At the
moment, we estimate the total funds under management by local
pension funds at Rp 8 trillion.

We expect that over the next few years, local pension funds
will become more accustomed to investing in the capital market,
and hence increase their exposure. Potentially, the Indonesian
pension funds could become a major market force in the next five
to eight years. The trend is very positive because pension funds
with long-term objectives are usually the type of investor that
can benefit from short term technical corrections like the ones
that we have seen in the past few weeks.

Local private investors seem to have returned to the market,
although it should be mentioned that their investment strategy
remains highly speculative and their time horizon very limited.
Once open-end investment funds become available in 1995, private
investors should seriously consider investing in the stock market
through such funds, and enjoy the benefits of professional fund
management.

In conclusion, we believe that the JSX will perform well in
1995, and investors should be buying now. Supported by a strong
momentum in economic growth and corporate earnings, we believe
that both local and foreign investors will be attracted by
Indonesia's strong growth momentum and promising long term
prospects.

After the recent weaknesses, valuations are now highly
attractive. The GT-DBS 50 index is currently trading at 15 times
its prospective earnings, compared to roughly 18 times at the
beginning of the year, leaving ample room for attractive capital
gains that could easily surpass 20 percent.

Teng Hong Joe is the General Manager of Business Development
of PT Gadjah Tunggal DBS Securities in Jakarta.

Windows A: In trading in such emerging markets as the Jakarta Stock
Exchange it is important to have a long time horizon.

Window B: Although the huge flow of new issues has been and will be
soaking up a huge amount of funds, we consider this factor to be
positive for the capital market.

Window C: Demand for infrastructure-related products and services will
remain strong over the next five to 10 years. While in times of
economic downturn such demand will be relatively resilient.