Stock market resurges

Foreign portfolio investors in Indonesia should have been immensely happy for the past five months, what with the rupiah appreciating by almost 8 percent and the Jakarta Stock Market (JSX) composite index resurging to almost 520 from 425 at the beginning of this year, a gain of 23 percent.

Indonesia's capital market has undeniably been the best performer in Asia in 2003.

This trend resembles the development in the first semester of 2002, when the bullish market sentiment drove the JSX index to as high as 545 in June, from as low as 380 in January.

The market bulls in the first half of 2002 rode on the backs of an increasingly stable macroeconomic and political climate, the successful strategic sale of Bank Central Asia -- one of Indonesia's largest banks -- and larger flows of foreign portfolio capital into Asian stock markets, such as in Thailand and Korea.

But the JSX index fell to as low as 325 after the terrorist attack in Bali in mid-October before recovering gradually to almost 425 at the end of that year, largely due to the new confidence generated by the successful sale of Bank Niaga to Malaysian investors and of telecommunications company PT Indosat to Singapore Temasek Holdings. The bitter reality, though, was that much of the gain made in the first half had been lost.

There is a similar trend in what has happened over the last five months. The market has been resurging on the backs of a steady decline to as low as 10.07 percent in the central bank's benchmark interest rate, a strengthening rupiah, significant progress in important reforms such as the strategic sale of another major bank -- Bank Danamon -- and a faster pace of asset disposals by the Indonesian Bank Restructuring Agency.

This confidence-building trend, combined with the fact that most stock valuations are still very low to allow for high gains, has wooed more foreign portfolio investors to the stock market. The steady decline in inflation has also allowed the central bank to further lower its benchmark interest rate, thereby luring more investors to its stocks and bonds.

The question now is whether this positive development will be sustainable for the rest of the year as well as next year, or whether this trend will face downside risks similar to those experienced in the second half of 2002.

There are several signs that could signal the direction toward which we may be heading in the next few months.

First, we should be careful about the underlying factors of the low inflation rate. However welcome the general price decrease, this trend also reflects a worrisome development in that a decline on the demand side has contributed greatly to the lower rate.

Except for cement and automobiles, which continue to enjoy strong sales, the demand for most consumer items has been declining, as reflected in the lower sales growth at supermarkets and department stores. Motorcycle sales, which reflect the purchasing power of lower-middle and low-income earners that make up the bulk of consumers, have been on a downward curve as well.

The weakening consumer demand was quite obvious in the declining economic growth, as private consumption has been the greatest economic locomotive for the past five years, accounting for over 70 percent of the gross domestic product.

GDP growth, for example, fell from 4.25 percent (year-on-year basis) in the third quarter of 2002 to 3.82 percent in the fourth quarter, and slipped further to 3.44 percent in the first quarter of 2003.

The 2002 annual reports of most publicly listed companies did show significant increases in profits, but further analyses concluded that most of their earnings were derived from lower costs, due to a stronger rupiah that reduced foreign-exchange losses and to lower interest.

Businesses need to book significant increases in net sales revenues in order to net bigger profits this year, especially because most companies have carried forward all their losses over the past five years and will again be subject fully to income tax.

Significant gains cannot be expected from higher business productivity, due to the persistently low pace of investment: Witness how most companies that floated bonds over the past year used their additional capital for restructuring old loans and not for operational restructuring, let alone expansion.

The market therefore needs more confidence-building developments to sustain its bullish trend. After all, the capital market is primarily a mechanism of investor perceptions and expectations.

A successful initial public offering by Indonesia's biggest bank, Bank Mandiri, early next month, will be a solid building block for confidence. Likewise, a credible program to exit the International Monetary Fund facility and a successful strategic sales of Bank Lippo and Bank International Indonesia later this year, will strengthen the positive cycle.

Investors will also be watching out for several new laws on next year's general elections, scheduled to be enacted within a few weeks. Election laws based on a unanimous political consensus will make businesspeople comfortable, as they will be reassured that political sentiments and competition during the 2004 elections will be well managed.